For the week, two-year Treasury yields dropped 8 bps to 5.09%. Five-year yields fell 7 bps to 5.03%, and bellwether 10-year yields declined 6 bps to 5.07%. Long-bond yields fell 6 bps to 5.12%. The 2yr/10yr spread ended the week inverted 2 bps. Benchmark Fannie Mae MBS yields declined 5.5 bps to 6.325%, this week performing about in line with Treasuries. The spread on Fannie’s 4 5/8% 2014 note ended the week three wider at 41, and the spread on Freddie’s 5% 2014 note three wider at 40. The 10-year dollar swap spread was little changed at 60.75. Corporate bond spreads generally widened somewhat. The implied yield on 3-month December ’06 Eurodollars dropped 8.5bps to 5.555%.
Investment grade issuers included Lehman Brothers $1.5 billion, Comcast $2.25 billion, RBS Global $785 million, Disney $750 million, Target $750 million, PPL Energy $450 million, HBOS $1.25 billion, Federal Realty Investment Trust $250 million, and McCormick $100 million.
Junk issuers included Nationwide Health $350 million, Enterprise Products $300 million, El Paso Performance $500 million, Iron Mountain $200 million, and Velocity Express $80 million.
Convert issuers included Archstone-Smith $500 million.
Foreign dollar debt issuers included Telecom Italia $2.6 billion, Turkey $1.75 million, Royal Bank of Canada $1.0 billion, TNK-BP Finance $1.5 billion, and Lafarge $2.2 billion.
Japanese 10-year “JGB” yields dropped 11 bps this week to 1.84%. The Nikkei 225 index declined 3%, increasing 2006 losses to 7.9%. German 10-year bund yields declined 8 bps to 3.98%. Emerging debt markets were generally resilient, while equity markets were under pressure. Brazil’s benchmark dollar bond yields added 5 bps to 7.05%. Brazil’s Bovespa equity index fell 2%, reducing 2006 gains to 5.7%. The Mexican Bolsa was hit for 7.6% this week (up 3.0% y-t-d). Mexico’s 10-year $ yields fell 4 bps to 6.09%. Russian 10-year dollar Eurobond yields dipped one basis point to 7.01%. The Russian RTS equities index dropped 4.2%, lowering 2006 gains to 31.9% and 52-week gains to 96.6%. Impressively, India’s Sensex equities index added 1.6% (up 13.6% y-t-d).
Freddie Mac posted 30-year fixed mortgage rates declined 5 bps to 6.74%, up 108 basis points from one year ago. Fifteen-year fixed mortgage rates fell 7 bps to 6.37%, 112 bps higher than a year earlier. One-year adjustable rates dropped 8 bps to 5.75%, an increase of 136 bps y-t-d and 5 bps over the past year. The Mortgage Bankers Association Purchase Applications Index rose 1.6% this week. Purchase Applications were down 23% from one year ago, with dollar volume down 24%. Refi applications declined 1.6% last week. The average new Purchase mortgage declined to $221,400, and the average ARM fell to $326,300.
Bank Credit jumped $21.7 billion last week to $7.941 Trillion, with a y-t-d gain of $435 billion, or 11.1% annualized. Bank Credit inflated $685 billion, or 9.4%, over 52 weeks. For the week, Securities Credit gained $7.8 billion. Loans & Leases jumped $13.9 billion during the week, and are up $286 billion y-t-d (10.1% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.3% rate y-t-d and 13.4% over the past year. For the week, C&I loans expanded $9.5 billion, and Real Estate loans added $2.1 billion. Real Estate loans have expanded at a 12.7% rate y-t-d and were up 12.1% during the past 52 weeks. For the week, Consumer loans increased $1.0 billion, while Securities loans declined $3.2 billion. Other loans rose $4.5 billion. On the liability side, (previous M3 component) Large Time Deposits added $2.8 billion.
M2 (narrow) “money” supply jumped $19.7 billion to $6.863 Trillion (week of July 3). Year-to-date, narrow “money” has expanded $174 billion, or 5.0% annualized. Over 52 weeks, M2 has inflated $340 billion, or 5.2%. Currency dipped $1.8 billion for the week, while Demand & Checkable Deposits surged $30.9 billion. Savings Deposits dropped $14.2 billion, while Small Denominated Deposits gained $4.8 billion. Retail Money Fund assets were unchanged.
Total Money Market Fund Assets, as reported by the Investment Company Institute, added $1.1 billion last week to $2.139 Trillion. Money Fund Assets have increased $82 billion y-t-d, or 7.4% annualized, with a one-year gain of $236 billion (12.4%).
Total Commercial Paper gained $2.6 billion last week to $1.786 Trillion. Total CP is up $145 billion y-t-d, or 16.4% annualized, while having expanded $255 billion over the past 52 weeks (16.6%).
Asset-backed Securities (ABS) issuance this week was a slow $8 billion. Year-to-date total ABS issuance of $381 billion (tallied by JPMorgan) is running about 3% below 2005’s record pace, with y-t-d Home Equity Loan ABS sales of $270 billion 8% above last year.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Andy Burt – were up $501 billion y-t-d (23% annualized) and $649 billion (17%) in the past year to $4.547 Trillion.
July 14 – Bloomberg (Nipa Piboontanasawat): “China’s foreign exchange reserves, the world’s largest, jumped by a third from a year earlier to $941 billion at the end of June… The Chinese government’s currency assets excluding gold increased from $711 billion in June 2005…”
The dollar index rose 1.3% to 85.78. On the upside, the New Zealand dollar gained 1.7%, the Australian dollar 1.0%, the Norwegian krone 0.5%, and the Iceland krona 0.4%. On the downside, the Israeli shekel fell 3.3%, the Colombian peso 2.3%, the Turkish lira 2.2%, the Japanese yen 1.5%, and the Brazilian real 1.5%.
July 12 – Bloomberg (Peter Wilson): “Venezuelan oil shipments to the U.S. fell 6 percent in the first four months of the year as President Hugo Chavez followed through on his plan to find new markets for his crude, according to data from the U.S. Energy Department. State-run Petroleos de Venezuela SA has been sending more tankers of oil and fuel to India and China…”
July 12 – Bloomberg (Ying Lou and Xiao Yu): “China, the world’s largest oil consumer after the U.S., imported 16 percent more oil in the first half of this year because of rising energy demand. Imports increased to 73.3 million tons (2.97 million barrels a day) in January to June…”
July 12 – Bloomberg (Jeff Wilson): “The U.S. spring wheat crop will be smaller than a year ago as unusually low rainfall the past six months reduced yields in the main growing regions of the Great Plains, the government said. Farmers will harvest 465.3 million bushels of spring wheat by October in the northern Great Plains, down 7.8 percent from 504.5 million a year ago…”
July 12 – Financial Times (Kevin Morrison): “The price of nickel on Wednesday surged to another record high in volatile trading, taking its rise over the last month to more than 50 per cent. The new peak came on a day that copper prices rose back above $8,000 a ton, and gold climbed above $650 a troy ounce… The benchmark three-month nickel price peaked at $26,600 a ton on the London Metal Exchange… The metal has risen about 90 per cent so far this year.”
July 14 – Bloomberg (Alaric Nightingale): “Oil companies are paying more than twice as much to haul 2 million-barrel cargoes from the Middle East to Japan as they were a year ago, seeking to secure supplies before an anticipated surge in crude prices.”
Gold jumped 5.5% to $664.15, and Silver added 1.1% to $11.53. Copper rose 4.7%. Trading to new record prices, August crude gained $2.94 to end the week at $77.03. August Unleaded Gasoline jumped 3.8%, and August Natural Gas surged 14.9%. For the week, the CRB index gained 2.6% (y-t-d up 7.6%). The Goldman Sachs Commodities Index (GSCI) surged 5.1% to a new record high (up 18.0% y-t-d).
July 10 – Bloomberg (Lily Nonomiya): “Bank lending in Japan climbed the most in a decade, adding to speculation the central bank will raise interest rates from zero percent this week. Loans rose 1.8 percent in June from the same month a year earlier, a Bank of Japan report…”
July 12 – Bloomberg (Lily Nonomiya): “Japan’s producer price gains held at a 25-year high as fuel and commodities costs increased, prompting manufacturers to raise prices… An index of prices that companies pay for energy and raw materials rose 3.3 percent in June from a year ago…”
July 14 – Bloomberg (Clare Cheung): “China’s economic growth probably expanded 11.3 percent in the second quarter from a year ago, faster than the 10.3 percent pace in the previous three months, the Oriental Daily said, citing a government researcher.”
July 12 – Financial Times (Lex Column): “Are Chinese exports now a source of inflation? Input costs in China are clearly rising. Manufacturing wages grew at an average rate of 14 per cent last year. The cost of raw materials and intermediate goods is increasing and the government is liberalising utility and fuel prices. This leaves exporters with a choice: accept lower margins or raise prices. There is evidence of both… Goldman Sachs expects Chinese annual consumer price inflation, currently 1.4 per cent, to reach 3 per cent by the end of 2006…”
July 14 – Bloomberg (Eugene Tang and Nipa Piboontanasawat): “China’s June money supply grew at the slowest pace in six months… M2…money supply…rose 18.4 percent from a year…”
July 10 – Bloomberg (Nipa Piboontanasawat): “China’s trade surplus widened to a record $14.5 billion in June as exports surged, increasing pressure on the government to let the yuan appreciate. The surplus soared from $13 billion in May…Exports jumped 23 percent from a year earlier…”
July 12 – Financial Times (Richard McGregor): “Royal Dutch Shell and a Chinese partner yesterday committed to a formal study of a coal-to-liquids facility in China’s western Ningxia province, a project that would represent one of the largest foreign investments in the country if it proceeds. Mr Lim Haw Kuang, the executive chairman of Shell in China, said at a ceremony to launch the project that a plant of the size envisaged by the partners would cost $5bn to $6bn to build.”
Asia Boom Watch:
July 14 – Bloomberg (Cherian Thomas and Kartik Goyal): “India’s exports of gems, textiles and other manufactured products accelerated in June, spurring industrial growth. Exports increased 25.1 percent…compared with a 15.8 percent rise in May…”
July 12 – Bloomberg (Cherian Thomas and Kartik Goyal): “India’s industrial production unexpectedly accelerated in May as companies made more cement and steel to meet demand at home… Production at factories, utilities and mines rose 10 percent from a year earlier following April's revised 9.6 percent gain…”
July 12 – Bloomberg (Yoolim Lee): “India is targeting average annual economic growth of 8.5 percent by 2011, said Montek Singh Ahluwalia, deputy chairman of the nation’s planning commission.”
July 12 – Bloomberg (Chan Sue Ling): “Assets under management in Singapore rose to S$720 billion ($456 billion) in 2005, partly because economic growth attracted the wealthy to the region, an official from the island-state’s central bank said. The 26 percent increase from S$572 billion in 2004 is the fifth year of double-digit growth in assets under management in the city-state…”
July 14 – Bloomberg (Amit Prakash and Haslinda Amin): “Thailand’s economic growth slowed to about 5.1 percent in the second quarter as a stronger baht curbed export competitiveness and a political deadlock delayed government spending, Finance Minister Thanong Bidaya said.”
July 11 – Bloomberg (Luzi Ann Javier): “Philippine exports growth slowed to a three-month low in May… Overseas sales rose 17.3 percent from a year earlier…”
July 13 – Bloomberg (Leony Aurora and Claire Leow): “Indonesia plans to invest 200 trillion rupiah ($22 billion) over the next five years to promote the output and use of alternative fuels using crops such as palm oil as crude costs rise to all-time highs.”
Unbalanced Global Economy Watch:
July 11 – Bloomberg (Theophilos Argitis): “[Canadian] Builders began construction on more houses than expected in June, and new-home prices rose a month earlier by the most since 1989, suggesting the nation’s housing market remains buoyant.”
July 10 – Bloomberg (Andrew Atkinson): “U.K. house prices rose at the fastest pace in a year in May, adding to evidence of a revival in the $6 trillion residential property market, a government report shows. Prices gained 5.6 percent from a year earlier…”
July 12 – Bloomberg (Brian Swint): “U.K. jobless claims rose in June to the highest in more than four years, damping inflation pressures and giving the Bank of England room to keep interest rates on hold.”
July 13 – Bloomberg (Fergal O’Brien): “Ireland’s economy grew 5.8 percent in the first quarter from the same period a year earlier, as employment growth and rising incomes boosted consumer spending. Consumer spending in the $220 billion economy grew an annual 6 percent in the quarter, while investment increased 11 percent…”
July 12 – Bloomberg (Lars Paulsson): “Italian electricity demand climbed 2 percent in June from a year earlier amid a rebound in industrial output. Hotter-than-average temperatures at the end of the month pushed consumption to a daily record.”
July 11 – Bloomberg (Evalinde Eelens): “Dutch industrial sales growth accelerated in May at the fastest pace since November 2000, adding to signs that Europe’s sixth-largest economy is recovering. Industrial sales rose 15.3 percent in May…”
July 11 – Bloomberg (Tasneem Brogger): “Swedish industrial production growth accelerated in May, led by textile and machinery manufacturing. Production grew 6.3 percent in May from a year earlier…”
July 11 – Bloomberg (Monika Rozlal and Nathaniel Espino): “Poland’s economy, the biggest among the 10 new European Union members, may grow an annual 5 percent in coming years… Exports rose a record 23 percent through April from the year-earlier period and Poland may lure as much as $10 billion of foreign direct investment this year, the most since 2000.”
July 11 – Bloomberg (Svenja O’Donnell and Marta Srnic): “Russia had a budget surplus of 1.07 trillion rubles ($39.7 billion) in the first half, helping the nation pay its foreign debt and paving the way for higher credit ratings.”
July 12 – Bloomberg (Daryna Krasnolutska): “Ukraine’s $84 billion economy expanded an annual 5 percent in the first half of the year, boosted by real estate development and transportation… In June, gross domestic product expanded 9.3 percent from the same month a year ago…”
July 11 – Bloomberg (Steve Bryant): “Turkey’s industrial production rose 9 percent in May from a year ago, accelerating from the previous month as a weaker lira helped drive exports.”
July 11 – Bloomberg (Hans van Leeuwen): “Australia’s home-loan approvals rose by the most in eight months to a record, adding to expectations the central bank will increase interest rates again this year. The number of loans to owner-occupiers to build or buy homes or apartments climbed 4.7 percent… Australian unemployment is at a three-decade low and wages are rising at a near-record pace…”
July 13 – Bloomberg (Hans van Leeuwen): “Australian employment rose the most in two years, prompting economists to bring forward their forecasts for a central bank rate increase to next month. Bonds slumped. Employment climbed 52,000, five times more than economists expected…”
Latin America Watch:
July 13 – Bloomberg (Adriana Arai and Patrick Harrington): “Mexico’s industrial output rose in May after a decline in the previous month… Output rose 5.7 percent from a year earlier…”
July 11 – Bloomberg (Romina Nicaretta): “General Motors Corp., the world’s largest automaker, is investing $240 million to start producing a new small car in Brazil, part of an effort to boost domestic sales and offset a slowdown in exports.”
Central Bank Watch:
July 14 – Financial Times (Michiyo Nakamoto): “The Bank of Japan sought to calm fears of a rapid tightening of monetary policy on Friday as it asserted its independence from political control and put an end to more than six years of zero interest rates. The central bank indicated it expected to keep interest rates very low for some time and would take a gradual approach to any further tightening – unlike the Federal Reserve, which has raised rates repeatedly in the past two years. ‘The chances are very high that an extremely low interest-rate level will be maintained for some time,’ said Toshihiko Fukui, BoJ governor. ‘We do not intend to carry out consecutive rate rises.’”
Bubble Economy Watch:
May Goods Imports were up 13.4% y-o-y to $154.3 billion, and May Goods Exports were up 12.6% y-o-y to $84.2 billion. At $63.8 billion, May’s Trade Deficit was the largest since January. June Import Prices were up 7.2% y-o-y. June Retail Sales were up 6.2% from the year earlier period, with Sales Ex-Auto up 9.2% y-o-y.
July 14 – “Texas Comptroller Carole Keeton Strayhorn today said the state received $1.49 billion in sales tax revenue in June, up 15.6 percent compared to June 2005… So far this calendar year, sales tax allocations to local governments are running 15.9 percent higher than last year.”
July 11 – Bloomberg (Christine Richard): “Getting the money for a U.S. education, whether it’s kindergarten or graduate school, increasingly depends on the bond market, where everyone from General Electric Co. to Goldman Sachs Group Inc. is rushing to meet record demand for student loans. Soaring tuition costs are driving the boom in federally financed and private loans, 75 percent of which Wall Street transforms into debt securities. About $44 billion of bonds tied to student loans were sold in the first half of 2006, Moody’s…says. At that rate, sales will top last year’s record $73 billion.”
July 11 – Bloomberg (Mark Pittman): “Car-loan delinquencies are rising, Standard & Poor’s said…as borrowers with lower credit ratings stretch out the financing of their vehicles over six years instead of the typical five-year period. Subprime delinquencies rose in the second quarter, and more payments later than 30 days are being reported for loans issued in 2004 than the year before, S&P said in the report, called ‘Auto ABS Is Downshifting.’”
Real Estate Bubble Watch:
July 12 - Dow Jones (Danielle Reed): “The Federal Reserve had hoped to make borrowing money a little tougher by raising interest rates by a cumulative 4.25 percentage points. But if the mortgage market is any indication, lending standards remain loose. While the Fed has been steadily lifting rates during the past two years, lenders have been expanding their loan menus to fit almost every conceivable financial circumstance, including the most cash-strapped. A wide array of non-traditional mortgages has allowed borrowers to keep up with the double-digit pace of home price increases as well as the squeeze of rising short-term rates.”
Energy Boom and Crude Liquidity Watch:
July 14 – Bloomberg (Elisa Martinuzzi and Lucian Kim): “OAO Rosneft, Russia’s state oil company, raised $10.4 billion in Europe’s biggest initial public offering in seven years, as record oil prices and increasing Russian energy production spurred investor demand.”
July 11 – Financial Times (Farhan Bokhari, Roula Khalaf and Gillian Tett): “A frenzy of construction in the oil-rich Gulf region has triggered a boom in the market for Islamic bonds, or sukuks, as devout Muslims increasingly demand financing instruments that comply with their religion. According to Khalid Yousaf, director of Islamic Finance at Dubai International Financial Centre, the Gulf is likely to see $9bn worth of new Islamic bonds issued over the next six months alone. Islamic bonds offer a share in the proceeds from a business venture rather than simply paying interest on a cash sum. The Koran, the Islamic holy book, bans riba – a word that can be interpreted as either usury or interest… Over the past five years the sukuk market has grown to $41bn, with $11bn worth of issues coming from the cash-rich Gulf region, according to Moody’s… Its rapid growth has attracted a host of western banks and law firms that are now scrambling to boost their capabilities in Islamic finance.”
July 14 – The Wall Street Journal (Tennille Tracy): “U.S.-based private-equity firms came out in full force during the first half of 2006, with 147 funds collecting a combined $96.4 billion, putting the industry on track to raise a record-breaking amount of capital this year. Fund raising was up 43% from the $67.5 billion collected by 138 funds a year earlier…”
July 12 – Financial Times (Peter Smith): “Blackstone is on course to set the high water mark in the exuberant round of private equity fundraising after saying it had attracted a record $15.6bn for what is now the world’s largest fund. The New York-based group has in 12 months scooped $30bn from investors for a range of vehicles, including real estate, corporate debt and hedge funds - only $2bn short of the amount raised in its previous 19 years of operation. Kohlberg Kravis Roberts is yet to finalise its latest buy-out fund, which could attract more than $15bn. However, KKR recently sold shares worth an additional $5bn after launching an Amsterdam-listed investment vehicle.”
July 12 – Bloomberg (Mike Anderson and Oliver Suess): “Karsten Bromann won’t take a vacation this summer. He’ll be tracking hurricanes for his hedge fund. Bromann, a hedge-fund manager at Zurich-based ISPartners Investment Solutions AG, plans to profit from forecasts of more violent storms. He’s snapping up ‘catastrophe bonds,’ as insurers sell more of the securities to protect themselves from increasingly unstable weather triggered by global warming…disasters such as Hurricane Katrina produced record claims of more than $90 billion last year. Hedge funds are embracing that risk, lured by yields of as much as 40 percentage points more than investment-grade debt. Investors forecast sales of catastrophe bonds may triple to $4 billion this year.”
After 9 months of the fiscal year, y-t-d Federal receipts are running 12.8% ahead of last year to $1.810 Trillion, with y-t-d Spending up 8.8% to $2.016 Trillion.
July 11 – Bloomberg (Roger Runningen and Ryan J. Donmoyer): “The Bush Administration cut its estimate of this year’s budget deficit by 30 percent to $296 billion amid a surge in tax collections from corporations and wealthy individuals… Government revenue has risen 11 percent so far this year even as the war in Iraq -- a total of $319 billion so far -- and the rebuilding of the Gulf Coast after last year’s hurricanes -- more than $100 billion – has pushed up spending.”
July 8 – Bloomberg (Miles Weiss and Roger Runningen): “Corporate tax receipts this year will likely cross the $300 billion threshold for the first time… The Congressional Budget Office…estimated that corporate receipts would exceed $330 billion in fiscal 2006, up 18 percent from 2005. That is double the 9 percent increase that the congressional budget agency estimated at the beginning of the government's fiscal year…”
July 14 – Associated Press: “The first half of the year was the warmest on record for the United States. The government reported Friday that the average temperature for the 48 contiguous United States from January through June was 51.8 degrees Fahrenheit, or 3.4 degrees above average for the 20th century. That made it the warmest such period since recordkeeping began in 1895, the National Climatic Data Center reported. No state was cooler than average and five states — Texas, Oklahoma, Kansas, Nebraska, and Missouri — experienced record warmth for the period.”
An Interview with an Esteemed Elder Statesman:
There should be at this point no dispute that a hostile geopolitical backdrop places inflated U.S. and global equities markets at considerable risk. And as the week progressed, it was almost as if I could sense that we were witnessing reality beginning to break through what has been to this point a well-fortified world of delusional wishful thinking. At a minimum, terror attacks in India, the specter of war in the Middle East, the ongoing disintegration within Iraq, $78 crude oil, along with Western drought and wildfires, made for a downright disturbing week of media coverage.
Hopefully the current turmoil that has quickly besieged Israel and Lebanon does not escalate into a full-fledged war. Yet there is the very real possibility for conflict to not only erupt but to fan out and envelope an unstable region. This imparts great uncertainty upon already highly unsettled global markets. That current developments might hasten what would appear an almost inevitable confrontation with Iran is the major wildcard. It is difficult to envisage a scenario that, at least in the near-term, frees oil markets from the fear of Iran and/or others seeking at some point to use tight global crude markets as a weapon of war. The U.S. consumer and economy is faced with an extended period of very high energy prices and will have no choice but to adjust.
Expanding on the theme that the U.S. Bubble economy is especially poorly positioned for the unfolding environment, it is worth a cursory examination of this week’s stock market sector performance. Notably, consumer and technology related stocks were under heavy liquidation. The S&P Computer & Electronic index was hammered for 11.5%, S&P Homebuilding index 10%, the S&P Retailing index 4.3%, and S&P Internet Retailers 8.8%. For the year, the Morgan Stanley High Tech index is now down 12.1% and the S&P Homebuilding index 37%. And while the Morgan Stanley Retail index is down only 2.5% y-t-d, it is worth nothing that the index has declined 7.3% over the past three month. Wal-Mart was pounded for 6.4% this week, while many of the specialty retailers were hit as hard or harder. On the upside, the AMEX Oil index gained 1% this week, increasing y-t-d gains to 19.3%. The S&P Oil & Gas Equipment index jumped 5% this week, S&P Managed Health index was up 2.6%, S&P Gas Utilities index up 1.9%, S&P Retail Drug index up 1.6%, and S&P Diversified REITs up 0.9%.
So far this year, the worst performing individual stocks include KB Home (down 45%), Goodyear Tire (43%), Ebay( 41%), homebuilder DR Horton (41%), Sandisk (38%), Juniper Networks (37%), and homebuilder Centex (36%). Leading stocks on the upside include Archer-Daniels-Midland (up 70%), Allegheny Technologies (63%), Kerr-McGee (60%), Nucor (51%), Marathon Oil (44%), Schlumberger (40%), US Steel (38%), and Baker Hughes (38%).
It is increasingly apparent that important developments related to the flow of speculative finance are beginning to take hold throughout the markets and, hence, the economy. This is an integral aspect of the commencement for the long overdue economic adjustment. Market rattling developments such as those experienced this week only accelerate the process. And, sure, there will be opportunities associated with the unfolding financial and economic realignment – especially if the Credit system continues to fire on all cylinders. But don’t think for a minute that such a massive endeavor will proceed without major upheaval for our highly imbalanced financial and economic systems. Overall, the U.S. economy will struggle mightily in the changing global environment, and there will be many more losers than winners.
After focusing on the markets and global developments throughout the day and then confronted with only a limited amount of time this evening, I nonetheless couldn’t resist viewing an interview of former Fed Chairman Paul Volcker on Bloomberg television. I then couldn’t resist transcribing much of the interview for readers. I hope you value the candor and wisdom shared by of one of our Most Esteemed Elder Statesmen as much as I do.
Al Hunt for Bloomberg: “The global economy today. Is it healthy and vibrant or is it skating on thin ice?”
Paul Volcker: “Well, (chuckling) it’s skating along nicely now but I think the ice is not as thick as I would like to see it. But we’re certainly gliding along very nicely at the moment. But it’s dependent upon some unsustainable trends: lack of savings in the United States – that deficiency is made up by a tremendous in pouring of capital and money from abroad – from Asia and now from the Middle East and elsewhere. And the amounts are large enough, so I think it is without question unsustainable…”
Hunt: “One of the issues you’ve talked about is China – the China currency. Some experts say that it may be undervalued by as much as 40%. Do you agree? Is the U.S. doing enough to pressure the Chinese?”
Volcker: “Well, I’m not one in favor of the United States to go out there publicly and pressure the Chinese. I think they will move – should move – when they find it in their interest. I think over time they will find it in there interest. But pushing them to do things they don’t want to do - I’m not sure it couldn’t backfire in the end.”
Hunt: “Let’s turn to the U.S. President Bush this week celebrated that the federal deficit has come down to $296 billion. He said, ‘This shows we have a fabulous economy.’ Do you agree?”
Volcker: “In some ways we have a fabulous economy, but we have developments in the economy, as I said, that aren’t sustainable. I don’t think we can go along not saving, and part of our dis-saving is reflected in that budget deficit. It’s a little smaller than projected but still too large for the current situation. So while the economy is doing nicely – it’s in some ways a fabulous economy – but we are consuming too much and investing too little…”
Hunt: “The holders of assets in this country have done rather well in recent years and those who depend on wages have struggled to keep up. There’s a wealth gap that has continued to widen. You’ve spoken to this in the past. Is that a long-run threat to Democratic Capitalism, and what should we do about it?”
Volcker: “It bothers me. I tell you, I don’t know why there has not been more discussion and more unhappiness about this because it’s become quite distinct. For a long time now - if we believe the statistics - the average working guy has not had an increase in income. But he’s working pretty darn hard these days… But there doesn’t seem to be much concern about it partly because, I guess, people find it fairly easy to get a job – at least they’re employed.”
Hunt: “What’s your reaction to the call for more transparency at the Fed?”
Volcker: “(chuckling) I think it is kind of ironic that Mr. Bernanke is criticized for a little too much transparency… I think what is important is what you do. Explain it as clearly as you can, but you don’t have to talk about it every day. That’s my theory.”
Hunt: “Ben Bernanke as new Fed chairman, with previous experience at the Federal Reserve. You’ve been there. You were the new Fed Chairman some 27 years ago, with previous experience. How steep is the learning curve once you step in the chairmanship shoes?”
Volcker: “It was easier for me because – Ben had been there for awhile but I had been with the Federal Reserve quite awhile. Maybe the most important thing was the challenge was very clear when I was there: you’ve got an inflation problem, and it was getting out of hand. And the country knew that something was a matter. There was unhappiness with the economy. That is a situation in which you can act, and you try to give a message as clearly as you can - you have to do a certain amount of talking to explain what you’re doing. In a way, while the economic situation was much worse, it was easier to act because it was clear what the enemy was, so to speak.”
Hunt: “But nine months ago you gave a speech when you said exactly that – you said in the U.S. inflation is getting out of hand. Is it out of hand today?”
Volcker: “Did I say it was ‘getting out of hand’?”
Hunt: “You did. Yes, sir.”
Volcker: “I must have said that in a dream or something. I worry about it getting out of hand. I don’t think it is out of hand today but it is obviously creeping up and I worry about people being too relaxed about it. I think given the problems we have, given our dependence on foreign capital, given our lack of savings – one thing we better be very careful about is that we maintain confidence in our currency. And that most of all means price stability. And there are some tendencies now toward greater inflation. I wouldn’t say it’s out of hand, but we better not let it get out of hand.”
Hunt: “Is it in general a good or bad idea for central bankers to have strict inflation targets?”
Volcker: “Well, I’m not an enthusiast about inflation targets. One thing, I stumble over the nomenclature. I think central banks should be aiming at stability not inflation.”