Geoeconomics India

Are we on the path to recovery?

2009-06-06T06:56:00.000-07:00

According to the latest data from Bloomberg, as of March 31, 2009 The US Treasury and Fed had committed a total of $12.8 Trillion to the financial rescue efforts. Out of this committed limit, $ 4,169.71 billion was drawn down as of March 31, 2009.

More on the US Treasury Finances

2009-04-29T11:35:00.000-07:00

The Auction schedule for the US Treasury debt securities shows the planned auction dates till November 05 2009.
As of April 28, 2009 the International Reserve Position of the United States shows total foreign exchnage reserves of $ 75, 877 million - or around $ 76b, according to this press release from the Department of the Treasury.

According to a Treasury statement to the Associated Press, The US Treasury plans to borrow $361 billion in the current April to June Quarter. Excerpt:

The $361 billion estimate for borrowing this quarter compared with borrowing needs of just $13 billion in the year-ago period. Normally the government's borrowing needs shrink sharply in the April-June quarter because of all the tax revenue being collected.

But, please remember:

Treasury also estimated it will need to borrow $515 billion in the July-September quarter, down slightly from the $530 billion borrowed during the year-ago period. The all-time high of $569 billion was set in the October-December period.

Here's a link to the latest Treasury Note, Bond and TIPS auction results.

How much should a Sovereign Borrow? - continued reasoning on the Treasury finances

2009-04-25T07:08:00.000-07:00

Chapter 18 of 'Principles of Corporate Finance' authored by Brealey & Myers deals with the interesting topic 'How much should a firm borrow?'. I don't know of any slim volumes in the public domain that present a similar reasoning for Sovereign borrowers. However, King Financing is one of the biggest games in the world. I bet the King Financiers have batteries of private PhDs churning out reams of ring-binded reports to work out the considerations for them. So I'm left to deal with this important topic with my own wits.
First of all you need to reason with the different categories of expenses or 'outlays' that a Government has. A Government needs money to provide certain public goods, for which it will collect taxes. For instance, people pay taxes and the collected amounts may be utilized to pay salaries for cops who maintain the law and order. Then you have outlays that are intended to create a long term benefit. For instance, the US Government can provide an economic stimulus for Chinese laptop manufacturers by giving free computers to school kids. The Government hopes that the kid will utilize the computer to pick up various skills, in turn earning a better income when it grows. This will result in a higher income tax collection for the Government in future.
It's important to split the Government outlays into items that are like operating expenses they have to provide required public services, and items that are intended to provide a long term return in terms of future GDP expansion and increased future tax collections.
The next part of the reasoning is on the interest the Government pays on its outstanding debt. You have to remember that a Government Bond holder isn't a beneficiary in future higher tax realizations of the Treasury. The debt holder simply receives interest and hopefully, the principal back from the Government.
The Government financier's interest is to make sure that the interest being paid is out of the money the Government is levying on citizens on an ongoing basis, and not out of the money that is realized from the Government borrowings themselves. A Government debt holder will expect interest to be paid out of the annual earnings of the Treasury. The one year term is derived on the understanding that most levies are collected on an annual basis.
From this reasoning, it is clear that on a stand-alone basis a Sovereign can borrow to the extent that the excess of its annual levies over outlays for operating expenses to provide routine public services is sufficiently large to meet interest payment obligations on its outstanding debt.
In case of the US Treasury, foreign central banks have a compulsion to lend money to them due to the military-diplomatic hegemonic compulsions. This factor enables the US Treasury to create a 'safety bubble' if it so chooses. Also, the triangular debt trading in the Treasury securities amongst the Treasury, Fed and primary dealers constitutes a method of extracting contributions to Treasury debt through the secret concession embedded in the Treasury Supplementary Financing Account.
In this framework, you need to analyze whether the US Treasury interest outgo is coming out of an excess of Treasury Revenues over routine operating expenses or not. If not, the Treasury is completely dependent on foreign central banks for financing. The day China decides to stop buying Treasuries, all other foreign central banks will have no choice but to follow suit, and in this scenario the US Treasury will go bankrupt.
To be continued ...

Updated: Is it time to prepare Insolvency Accounts for the US Treasury?

2009-04-23T21:31:00.000-07:00

Operating Cash Balance: The operating cash level of the US Treasury is mentioned in the daily Treasury statement to be $295,462 million as of 22-APR-2009. Out of this $199, 929 million is in the Treasury Supplementary Financing account.
Revenues and Outlays: The monthly Treasury statement contains the data on past revenues and outlays of the US Treasury. Last month, i.e. in March 2009, the US Treasury spent $192,273 million more than they earned. Since October 2009, their total excess of spending over revenue is $ 956,799 million - or nearly a trillion dollars.
Expected Deficits:
Here's a preliminary analysis of President Obama's budget proposals under the aegis of the Director of the Congressional Budget Office. Excerpt:
"CBO projects that if those proposals were enacted, the deficit would total $1.8 trillion (13 percent of GDP) in 2009 and $1.4 trillion (10 percent of GDP) in 2010. It would decline to about 4 percent of GDP by 2012 and remain between 4 percent and 6 percent of GDP through 2019.The cumulative deficit from 2010 to 2019 under the President’s proposals would total $9.3 trillion, compared with a cumulative deficit of $4.4 trillion projected under the current-law assumptions embodied in CBO’s baseline. Debt held by the public would rise, from 41 percent of GDP in 2008 to 57 percent in 2009 and then to 82 percent of GDP by 2019 (compared with 56 percent of GDP in that year under baseline assumptions). ”
The US Public Debt:
As of this writing, the US public debt totals $11.184 trillion.
Sources of financing:
One of the main sources of financing for the US Treasury is Chinese purchases of Treasury and other dollar denominated securities. Dr. Brad Setser at the Council on Foreign Relations is one of the world's foremost experts in the area of balance of payments and global capital flows; and he has taken a specialized interest in studying the size of holdings, currency composition and portfolio allocation of the world's central banks and sovereign wealth funds.
In this paper written along with Arpana Pandey for the CFR Center for Geoeconomic Studies, Dr. Setser has described estimation methodology and data to understand the activities of the People's Bank of China and its associated Sovereign entities.
Yesterday, China revealed its holdings of gold, and here's an article in the Financial Times on that topic.
Note on the United States Public Debt:
Here's a link to the Bureau of the Public Debt web site and on the site if you go to the link "see the U.S. Public Debt to the penny" - the total as of this writing is $11, 184, 922,662,862.85. Of this total, "Intragovernmental holdings" form $4.299 Trillion, and "Debt Held by the Public" forms $6.885 Trillion. In most media and official reports, only the $6.885 trillion is taken into account as US public debt. Typically, that calculation yields around 40+ % of GDP as the US Public Debt.
Understanding the correct nature of "intragovernmental holdings" provides you the accurate, and more practical picture. The contribution made by US citizens towards social security, and other sources of revenue of US government departments, was added to the Congressional Budget as an appropriation. The US Treasury then spent those amounts and issued debt securities to those other US Government entities. Mostly, the $ 4.3 trillion is US Treasury debt held by the Social Security Fund.
The common reasoning provided for not taking the Social Security appropriations into the Us public debt calculation is that that debt is simply not held by the public, and not settled in the market. The US Treasury has payables and liabilities towards Medicare and Social Security that are as yet unfunded.
My view is that what really matters is the cash flow situation. The $4.3 trillion owed to Social Security Fund can be seen as "flexible debt". As long as the Treasury is able to meet the outflows towards its unfunded liabilities, the intragovernmental debt holdings aren't that much of an issue.
Note: I've updated my comment on the US Public Debt after some further serious thinking.
To be continued ...

Governor Zhou's Proposals and Geithner's reaction - the World's Future Reserve Currency System

2009-03-28T04:18:00.000-07:00

Zhou Xiaochuan, Governor of the People's Bank of China made concrete, long term proposals to reform the international monetary system. Timothy Geithner's reactions to Governor Zhou's proposals caused a big stir amidst market participants. One of the constraints that leaders have while writing and speaking in public is that issues with strong geo-political overtones, especially those that touch on or highlight international competition or conflict; need to be discussed indirectly. The purpose of my essay below is to present the implications of Governor Zhou's proposals in a slightly more transparent manner so that market participants can understand more clearly and draw the right conclusions to guide their decisions. At this link you can watch the full video of Geithner's remarks at the Council on Foreign Relations.

The Hollywood Economy

2009-03-25T11:42:00.000-07:00

Here's an interesting article by Gloria Goodale in the Christian Science Monitor on America’s new-found obsession with summer blockbusters. Michael Cieply in the New York Times also wonders at Americans flocking to movies in the downturn.
And here’s a link to weekend by weekend box office numbers for late 2008 and early 2009.
And here's another article on the movie ticket boom from boston.com.

If Americans don't consume, will global trade crash and burn to the ground?

2009-03-16T05:45:00.000-07:00

A couple of comments I made on another blog page:
One of the big lenses through which most Americans view the world’s trade is very approximately as follows: “If Americans don’t consume, global trade will crash and burn to the ground.” I expect that Fabius Maximus would have followed the reasoning in Brad Setser’s explanation for China’s February trade data. China’s exports are showing a decreasing year on year rate of decline in February versus January. The Chinese Lunar New year dates are used by Setser, Macroman, and other commentators to explain this trend. They’re unable to accept that China’s overall export volumes are not responding as expected to the fall in US aggregate demand.Another lens through which several people view the US status is that might be possible to reduce the import dependence through a “divide and rule” policy. For instance, one of the themes I’ve come across is that you can massively do away with imports from China through tariffs, etc, while the oil-exporters continue to hold dollar assets. Thus a currency crisis is prevented, and an imaginary “rapid and orderly rebalancing” can ensue, even as millions more are laid off abroad and political crises emerge there. The divide and rule advocates are unable to see the new alliance amongst the Eurasian powers, consisting mainly of Germany, Russia and China. Despite various differences amongst countries, the US dollar hegemony has become a rallying cry, and the US is now more widely seen in the world as the common enemy of all. (246 words)
What FM seems to be thinking about is a gradual import substitution, sector by sector, whatever. This is radically different from the “rapid and orderly” fantasies.The ruse here is very simple. Most people, unless they’re specialized in economics, or naturally very bright, have a belief that doing away with imports will result in higher local employment. For instance, people seem to imagine that, if you ban imports from China, local companies will come up rapidly, and local people will get jobs to manufacture things imported from China. The fact is that real wages of US workers are much higher than almost anywhere else. Consider a situation where all kinds of items, from textiles, nail clippers, electronics, etc are produced locally, and have to be priced accordingly. This provides two choices; either reduce the wages of US workers, or increase the prices of those goods. Neither of these choices results in a better economy or a better standard of living for people. Apart from reducing people to consuming only the barest essentials, the other effect is that aggregate employment will drop drastically. There’s no way to employ lots of high-paid Americans and hope to sell the same volumes at high prices. If you don’t pay the Americans well enough, despite lower prices, they won’t buy so much, so the factories will be unviable. As for hoping to increase exports, which country will buy US exports in the presence of a huge US Tariff? (245 words)

Fall of the Berlin Wall - Has the American Empire Collapsed?

2009-03-14T16:42:00.000-07:00

Have a look at this video , showing a historic moment - the bulldozer gores into the Iron Curtain on the Bornholmer Strasse. And here's the official video from BBC archives.

Dollar Funding of Foreign Banks - some notes

2009-03-12T21:15:00.000-07:00

I looked at line item 5) in the TIC data on “Claims on Foreigners by Type and Counterparty”. The item is called “Foreign Banks, including own foreign offices”.The claims peaked at $2.170 Trillion in August 2008. The claims declined to $1.937 trillion by December 2008, the latest data available at the link below. The decrease of $233 billion in claims payable in dollars by foreign banks and foreign branches of US banks is better reflected in the TIC data.Also, the level of around $2 trillion tallies more closely with the BIS estimate of the dollar funding gap faced by foreign banks. The total liability of US banks to foreign banks by end 2008, $ 637.6 b is probably not reflective of the total amount of dollar funding circulating in foreign banking systems.
http://www.treas.gov/tic/bctype.txt
@Brad: The negative liability line probably represents transfers from branches of foreign banks located in the US to their branches outside the US.Liabilities of US Chartered banks to foreign banks grew from $293.8 b at the end of 2004 to $637.6 b at the end of 2008. This growth creates a picture of increasing borrowings of US banks from foreign banks. Also, the growth in US banks liabilities to foreign banks doesn’t explain the increase in liabilities of foreign bank branches to foreign banks. US Banks liabilities to foreign banks grew from $ 420.3 b at the end of 2006 to $478.2b at the end of 2007, an increase of only $ 57.9 b. The liabilities of foreign branches to foreign banks grew from -$255.3b to -$424.50b between 2006 and 2007, an increase of $ 169.20 billion in owings from foreign banks to their branches here.I remember seeing a line item in the TIC data reflecting something like claims on foreign banks payable in dollars.I think that might be a better indication of the amount of dollar loans not rolled over/withdrawn from foreign banks.

Brad: the combined assets of the broker-dealers and funding companies rose by around $325b (if I got the math and netting right)

Me: From L129 and L130 I got an increase of $326.60 b. I took the funding cos investments in broker dealers out of the total assets for 2008 and 2007. The difference could be rounding.

IMF quotas analysis with links

2009-03-10T14:56:00.000-07:00

The link below has the voting power shares at the IMF.
http://www.imf.org/external/np/sec/memdir/eds.htm
In simpler terms, a voting/quota share determines the amount of forex that each country is eligible for out of a total increase in SDRs. SDRs are electronic credits from the IMF to countries, that can used for foreign exchange. This is like an equity stake that each member country gets in IMF combine.
The link below takes you to an FT Op-ed by Edwin M. Truman, after he took office as the US Treasury’s IMF person. (Title: ‘How the IMF can help save the world economy’)
http://www.ft.com/cms/s/0/ccafa8d4-09b8-11de-add8-0000779fd2ac.html
And here’s a link to another Op-ed by Ted Truman on IMF Reform:
http://www.petersoninstitute.org/publications/opeds/oped.cfm?ResearchID=1106

Ted Truman proposes overall, an increase of $250 billion in the world’s foreign exchange through SDR credits from the IMF. And, somewhere between 5 and 10 percent of voting rights will be re-distributed away from “traditional industrial countries” to others (as a best case).

Currently the United States has 16.77 % of IMF voting rights, and China has 3.66%. Australia has only 1.47%. Geithner was the US Treasury's representative to the IMF during the 1998 Asian crisis. He personally made sure with his program then, that all those countries would learna lifelong lesson not to depend too much on foreign loans, and to build a large enough forex reserve.

IMF Quotas

2009-03-10T14:21:00.000-07:00

The IMF’s list of Directors and Voting Power provides data on the IMF Quotas.

For reference - buffer against possible censorship by Brad Setser

2009-03-09T17:33:00.001-07:00

Consider this confusing sentence from the Baba/Ramaswamy paper:
“US banks’ need for European currencies is much smaller because US banks have leveraged their domestic operations with foreign assets much less.”
When you’re telling lies with statistics, it requires the use of complicated terminologies with clever twists in them as well. Such as, for instance, Brad Setser’s phrase “financing the US current account deficit”.
There is, in fact, no such thing as a European bank “leveraging domestic operations with foreign assets”. The more you think about this, the more confused you will be.The financial laws of gravity are simple. A global bank will source funds where interest rates are low; and lend where interest rates are high. Given that both short term and long term rates were much lower in the US, European banks borrowed in dollars and lent in local currencies.“Interbank market” is a euphemism for a bank HQ’ed, say, in Germany, borrowing USD from a local US bank. When this type of source is disrupted, the dollar funding can’t go on any more.Secondly, the existing USD loans weren’t rolled over.Which is why there had to be inter-central bank currency swaps.Apart from the US and the UK, I haven’t seen many reports of retail mortgage borrowers in any geography defaulting in large numbers. Of course, a liquidity crisis can transform into a solvency crisis rapidly.But the BIS papers are a clever attempt to confuse readers on the topic of “European banks’ need for dollar funding”. That ‘need’ developed as a result of lower US rates; and persisted due to non-rollover of existing dollar debt.

Reasoning out how the crisis spread around the world

2009-03-09T16:51:00.000-07:00

The BIS paper on the dollar funding shortage doesn’t clearly explain how the crisis was transmitted from the United States to Europe.It’s easier to begin with understanding as to how the American problem was transmitted to different emerging markets. For several years emerging markets around the world had high interest rate regimes and had good growth due to secular strucutural changes in their domestic economies. Banks headquartered in New York,London made out loans denominated in USD to say, banks headquartered in BRIC countries. Rolling over the shorter term lower interest rate USD loans was the source of funding for a number of banks in the BRIC countries, who were able to profit from the interest rate spread across the currencies. Secondly a number of foreign institutional investors held equities in these markets, sometimes more than 20% of the total local market cap. These investments were made by using the integration of i-banking and commercial banking; and used the same source of funding - the New York/London interbank/FX Swap/Central bank dollar funding sources.Once the credit crisis broke loose in the US, the disruptions led to a vary large correction in these exchanges, and a local liquidity crisis due to inability to roll over the USD loans.The BIS paper classifies banks by their headquarters in different European countries. It totals up the “dollar denominated claims” of those banks, and totals up their “local currency assets”. Then it shows that the excess of the dollar denominated claims over the local currency assets was funded through the above three sources of USD funding.There are two important aspects here. A “dollar denominated claim” might perhaps be held in any geography, and not only in the US. This is because banks might lend to say I-Banks that might then go and invest in EUR denominated equities. Or a bank HQ’ed in Germany might make out a dollar-denominated loan to a bank HQ’ed in Eastern Europe; and the Eastern European bank might then lend to the local emerging market in its own currency. And so on.This requires a lot of further analysis and thinking. To be continued…

Brad Setser propagates H1B myths by blocking visa info at his blog

2009-03-09T14:59:00.000-07:00

In the middle of another discussion some commentators at Brad Setser's blog started discussing BofA's decision not to recruit foreigners on H1B any more. Specifically the discussion was from some people with European MBAs. I made a comment highlighting the problems associated with the H1 B visa. Namely, the inordinate amount of time it takes to get basic employment freedom in the United States - the defender of the free world. Also, the near bonded labor status of people working on H1B visas.
Also, I highlighted the highly expensive nature of any kind of technical training in the US, and the lack of programs in US corporations to improve skills of workers. Thirdly, I highlighted the bloated bureaucracy in most American Fortune corporations, and compared them unfavorably with State run bureaucracies in countries like India.
Brad Setser had no problem with wide eyed foreigners breathlessly discussing Bank of America's decision not to recruit bonded laborers on H1Bs. But as soon as some real information about the evil H1B visa modern slave-trading scheme was made available to his reading public, he deleted the comment.
H1B visas are just a form of modern slave trade. You get a H1B visa, then every time you think of changing your job, the new employer has to pay $10,000 to transfer it.Secondly, you can’t change your job without losing status if you have a parallel employment based immigration petition.It takes something like 7-10 years before you can get a permanent residence on this track. Then, another 5 years of maintaining residence before they finally give you American citizenship.Meanwhile anything from 10 hours to 15 hours of every weekday of your life is mortgaged to the folks who filled in your H1B forms. And in a recession if you lose your H1B job and stay back in the US to look for another one; you could end up arrested, jailed and tortured by the Homeland Security Police.Immigrating to the US is a good way to lose your job flexibility; also most people working in the US don’t have access to train for new skills; you become a typical overspecialized American worker. What you knew technically when you landed in the US is what you’ll know 15 years later, when you get an American passport.There are some chances that you can become a typical American corporate bureaucrat meanwhile. American Fortune Company bureaucrats are technically behind even bureaucrats in Indian State Governments manning Animal Husbandry departments. Using a blackberry is a skill you can pick up in any country in less than a month; and that’s just about what you can learn professionally by working in the US.

The Lehman collapse and its connection with the European banking collapse

2009-03-08T22:29:00.000-07:00

The Lehman collapse and its connection with the European banking collapse is examined in this Baba/Ramaswamy paper at the BIS.

More on the US Dollar Shortage in global banking

2009-03-07T17:27:00.000-08:00

As part of its latest quarterly review, the BIS has examined the shortage of US dollars in the international banking system.
Excerpts:
"
Global banking activity had grown remarkably between 2000 and mid- 2007. As banks’ balance sheets expanded, so did their appetite for foreign currency assets, notably US dollar-denominated claims on non-bank entities, reflecting in part the rapid pace of financial innovation during this period.
European banks, in particular, experienced the most pronounced growth in foreign claims relative to underlying measures of economic activity.
We explore the consequences of this expansion for banks’ financing needs. In a first step, we break down banks’ assets and liabilities by currency to examine cross-currency funding, or the extent to which banks fund in one currency and invest in another (via FX swaps). After 2000, some banking systems took on increasingly large net on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off-balance sheet, the build-up of large net US dollar positions exposed these banks to funding risk, or the risk that their funding positions could not be rolled over.
To gauge the magnitude of this risk, we next analyse banks’ US dollar funding gap. Breaking down banks’ US dollar assets and liabilities further, by counterparty sector, allows us to separate positions vis-à-vis non-bank end users of funds from interbank and other sources of short-term funding. A lowerbound estimate of banks’ funding gap, measured as the net amount of US dollars channelled to non-banks, shows that the major European banks’ funding needs were substantial ($1.1–1.3 trillion by mid-2007). Securing this funding became more difficult after the onset of the crisis, when credit risk concerns led to severe disruptions in the interbank and FX swap markets and in money market funds. We conclude with a discussion of how European banks, supported by central banks, reacted to these disruptions up to end- September 2008. "
...
On the European Banks' reactions to the crisis:
"
Banks reacted to this shortage in various ways, supported by actions taken by central banks to alleviate the funding pressures. Since the onset of the crisis, European banks’ net US dollar claims on non-banks have declined by more than 30% . This was primarily driven by greater US dollar liabilities booked by European banks’ US offices, which include their borrowing from the Federal Reserve lending facilities. Their local liabilities grew by $329 billion (13%) between Q2 2007 and Q3 2008, while their local assets remained largely unchanged.
This allowed European banks to channel funds out of the United States via inter-office transfers (right-hand panel), presumably to allow their head offices to replace US dollar funding previously obtained from other sources.
"

Ted Truman and new IMF Dreams - watch this carefully!

2009-03-06T17:44:00.000-08:00

At this post on Dr. Paul Krugman's blog, Ted Truman is reported to have joined the US Treasury to reform the IMF. An article on Ted Truman's joining the Treasury has links to his writings. Hmm...let's see what Ted Truman has been advocating for the IMF.

Thomas Hoenig, President of Kansas Fed - mulls pre-privatized "bridge bank" resolution of insolvent US banks

2009-03-06T11:18:00.001-08:00

Calculated Risk reports on the Koenig speech with characteristic alacrity.

Dr. Brad Setser on Sovereign Wealth, Sovereign Power and Foreign Official Agency Purchases

2009-03-06T05:37:00.001-08:00

Here's an extract from Dr. Brad Setser's paper titled Sovereign Wealth and Sovereign Power. (the emphasis is mine)
"
For U.S. policymakers today, complacency is tempting because of comforting arguments that it is not in creditors’ interests to precipitate a crisis. One comforting argument is that it would take a decision by a major creditor to dump all dollar reserves to cause a run on the dollar — and that this sort of decision is so drastic as to be unlikely.
But history contradicts this argument. During the Suez crisis, both British chancellor Harold Macmillan and Prime Minister Anthony Eden were convinced that the U.S. government was behind the run on the pound. But the U.S. government actually reduced its sterling holdings by only four million pounds—or around $11 million dollars—between the end of September 1956 and the end of December, a fraction of the $450 million drain from September through November with which HM Treasury had to contend.43 The United States did not need to sell pounds to put pressure on Britain, just as Russia, China, or Saudi Arabia might not need to sell dollars to put pressure on the United States today. As W. Scott Lucas writes: "The Americans did not have to sabotage the pound to influence Britain ... they merely had to refuse to support it."
Contrary to what the comforting narrative might suggest, a country seeking to use its holdings of dollars to influence U.S. policy has options that fall short of the "nuclear option" of dumping large quantities of dollar reserves.
– A creditor government could sell holdings of "risk" assets and purchase "safe" U.S. assets, creating instability in certain segments of the market. This could be done without triggering the appreciation of its own currency against the dollar or directly jeopardizing its exports.
- A creditor government could change how it intervenes in the currency market. A country, for example, could halt its accumulation of dollars without ending all intervention in the currency market if it sells all the dollars it buys in the market for other currencies.
– A creditor government could stop intervening in the currency market, halting its accumulation of foreign assets, whether in dollars or other currencies.
– A creditor government could halt its intervention and sell its existing stocks of dollars and dollar-denominated financial assets, the "nuclear option." If it held a large equity portfolio, this could include large stock sales.
"
In this essay at his blog Brad Setser says "And now even government-backed Agencies are too risky. " (He's discussing the Russian Federation's 2008 action to offload all holdings of Agencies, while accumulating increased volumes of Treasuries.)
There have also been other essays from Dr. Brad Setser, comparing the Fed's willingness to take a higher level of risk, to provide stability during the crisis; against the de-stabilizing influence exercized by foreign central banks, such as the People's Bank of China when they dumped Agencies during the crisis. (I'll try to provide more links to Brad's blog essays and excerpts as time permits)
While he doesn't explicitly state this in his latest essay, Dr. Brad Setser has been advocating increased Agency purchases from foreign central banks for some time now.
If foreign official creditors were excessively concerned about exercising influence on US policies; they could have done that by making conditions in return for continued lending to the US Agencies in 2008. Setser's data clearly shows they massively exited their Agency holdings, and exchanged them for Treasuries. Since there is no information about any conditions made by them that the US Government did not meet, the foreign official Agency debt sell off is an indication that foreign official creditors, in 2008, did not pursue the agenda postulated in Dr. Brad Setser's paper on Sovereign Wealth and Sovereign Power.
In September 2008, the Henry Paulson announcement of a conservatorship for the Agencies made it abundantly clear that though they are known, till date as "Government Sponsored Enterprises" or alternatively as "Agencies" of the US Government; in fact, they are private entities enjoying only a limited guarantee from the US Treasury. Clarification of the non-Governmental status of the Agencies, clearly, was the main cause of the foreign official sell-off in Agencies.
If foreign central banks were to buy Agencies now, that would in fact signal some nefarious intentions on their part, as long as you still accept the risk of foreign official creditors wanting to use their creditor status to influence US policies. So I see a discrepancy here between the recognition of that risk in Brad Setser's paper linked above; and his on going advocacy of a stabilizing influence from foreign official Agency purchases.

Trans-Pacific Geopolitical Relations

2009-03-05T16:20:00.000-08:00

Brief Background:
The war in Iraq, that is still being unwound, led to the loss of life for an estimated more than 100,000 Iraqis, and more than 4,000 US soldiers. The war was provoked by what turned out to be wrong information indicating a massive build up of WMD in Iraq, and suspicions that the Iraq regime was complicit in the 09/11 attack. This war contributed a great deal to the failure of the incumbent and the Republican candidate in the recent US Presidential elections. The process by which this war came about has been highlighted in various forums, as being a simple result of wrong judgements and evaluations by military intelligence experts.
Another, separate, unconfirmed, reason postulated is that the war was provoked deliberately to deal with the Iraq regime's actions to change the composition of their reserve currency from USD to EUR; and to propose exports of their crude output denominated in a currency other than USD; thereby threatening the US geopolitcal influence over the Middle East and the petroleum trade.
Similar ideas about moving away from the USD status as a reserve currency, and the denomination of international trade settlements in USD have been expressed by the leaders of Iran,Germany,Russia, France and Venezuela, according to various press reports. Also, there are reports that China plans to get the RMB accepted in its region as a reserve/trade settlement currency in a very limited way. At the same time, with the exception of Iran, the intention of the other central banks seems to be to gradually re adjust away from holding mainly USD to holding a combination of USD and other currencies.
In this context, it is likely that the USD exchange rate will gradually decline, leading not only to a more multipolar geoeconomic order, but most importantly, an opportunity for the United States to gradually rebalance its trade with several large economies. If things go according to plan, the United States will most probably emerge from the 2008 crisis with a much stronger economy, increased exports, a more feasible and sustainable USD exchange rate; and still retain its military strength and all other aspects of soft power and geopolitical influence.
Note 1) While most people write very dreamily about a "New World Order" I tend to think that the only notable changes are likely to be economic, rather then geopolitical; a weaker dollar, and increased US exports to other countries, in my view, increase US influence rather than decrease it.
2) Though we're already in the third month of 2009, I'm yet to accept the popular notion that the rest of this year will continue to be a 'crisis'. In my view, even the emergence of a clear direction towards economic recovery should lead to declassification of the global economy as being in a 'crisis' of some sort. Recessions are in the mind, as Dr. Amartya Sen pointed out recently. (Amartya Sen is well known for proving, for instance, that many aspects of social development, such as literacy, are independent of economic development, such as per capita GDP' through comparison of these variables across different Indian states.Also, his research in economic history on the Bengal Famine showed that in fact, there was no physical shortage of foodgrains during that famine. Traders hoarded foodgrains due to the widespread belief and expectation of a famine, leading to massive starvation and loss of life for humans and cattle, in the his analysis of the history. If cows can die in the Bengal Famine history, as Amartya Sen showed, due an imaginary shortage of food grains in traders' minds; US banks can refuse to lend money to anyone, due to an entirely imaginary 2009 Global Depression)
To be continued ...

RMB as a reserve currency, the size of China's stimulus and a comment on current account imbalances

2009-03-05T11:26:00.000-08:00

Here's a link to my post below on the RMb as a reserve currency.
Also here's a link to Dani Rodrik's accurate statement of world stimulus packages.
China's stimulus is $586 billion, or 6.9% of GDP; the US stimulus is $787 billion, or 5.5% of GDP.

Here is a comment I made to one Rudiger von Arnhim at Brad Setser's blog:
@Rudiger von Arnhim: I noticed you have a Ph.D in economics from a US university, specializing in international economics. Is it possible for you to define “external imbalances” for me? e.g. if US consumers import 10 widgets from China, and China imports 1 widget from the US. If exchange rates adjust freely, will this result in an “external imblance”?When exchange rates DON’T adjust, who’s to blame; the petrodollar recycling scheme since 1971, the 1944-1971 Bretton Woods, or China’s ‘dollar peg’ since 2000? And where will exchange rates be if you remove China’s dollar peg?Who asked the Federal Reserve not to regulate on loan eligibility by monthly income? Was that the People’s Bank of China?When RMB strengthens against USD, how much will US exports increase to China, or elsewhere?There are 20 millions jobless and social-security-less workers in China as of today, by Government estimates. Has this led to even ONE more American job anywhere?
Update: I made some changes to this post and removed another one I made after this.

RMB as a Reserve Currency: Links to two reports: Reuters and China Daily

2009-03-05T10:12:00.000-08:00

Sources: China Daily, China State Council, Zhao Deming, official in charge of finance in Guangxi province.
China Daily reports internationalization of the yuan

Reuters Report on XE.com about using RMB as a reserve currency

The Dollar Funding Crisis in the International Banking System

2009-03-05T10:00:00.000-08:00

Here's a link to this Interesting Paper from the Latest BIS Quarterly Review

PS: The link was posted by an anonymous blogger by nickname RE on Brad Setser's blog page, that is otherwise mainly concerned with current account imbalance propaganda and rarely looks at objective material such as this.

Update: In a comment today Brad Setser says he will comment on the BIS papers/articles about the dollar funding crisis

Will the Us dollar get weaker or stronger now?

2009-03-04T22:35:00.001-08:00

Here's my view:
Yen and USD-funded carry trades will be put on massively once the credit crunch eases. I’m not sure what level the yen and USD exchange rates will settle down at.As the RMB gets acceptance as a reserve currency, Russia, Germany, France, Iran, Venezuela all continue to shift their forex reserves composition to a combination of RMB, JPY, Russian roubles, EUR, etc. The USD will draw strength mainly from its RMB peg.The US still has a perhaps 4-5 years available to deal with an emerging balance of payments crisis. That period, according to Obama’s plan, is to be used to reduce dependence on imported oil, and build a more skilled workforce that can provide better export performance in a weaker dollar world. These two factors can actually be expected to mitigate the effects of an emerging external finance solvency crisis for the US.In between, there are old-style trade protectionists in the guise of current account imbalance theorists; calling for an immediate disruption to the external financing flow to the US. If this goes through, the US will definitely face a sovereign default before the end of this year or the middle of next year.

PS: I posted this as a comment on Brad Setser's blog. As anybody can see, it is quite relevant to the topic of his blog post today;but you should wonder if he will be able to tolerate such a radical difference with his views.

My comment below has been approved on Dr. Krugman's blog!

2009-03-04T18:43:00.000-08:00

Showing, therefore, that I'm allowed there ...

This Comment at Paul Krugman's New York Times Blog

2009-03-03T21:42:00.000-08:00

I just uploaded this comment to Dr. Krugman's post titled hey-who-you-callin-neo-wicksellian?
I read an interesting paper on quantitative easing written by a couple of economists at the Fed. Apart from citing the Japanese case, they also go into something called a “floor price system”, that was an innovation of the New Zealand Central Bank. It would be nice to get some further explanation of the use of the short term interest rate and other factors that can be used to influence money supply. Here, I notice the argument that if the money supply increases in the presence of a ZIRP, you’re just substituting cash for short term debt. This is something I’ve never come across and it would really be useful if this can be expanded on further, either by Dr. Krugman or other knowledgeable commentators.— Indian Investor

This comment has nothing controversial in it; it just asks for further explanation that would be useful to understand better. There's a surprising change today. Previously for several days, as I noted before, my comments there wouldn't appear in the status "awaiting moderation" after I uploaded but today this comment does appear in that status!

The Indian Economy

2009-03-03T11:49:00.000-08:00

The latest press release from the Central Statistical Organization, which is part of the Ministry of Statistics and Programme Implementation, Government of India contains the latest official estimates of GDP for the quarter ended December 2008.

I recommend reading the complete 6-page press release.Following are the components of GDP on the output side; the percentages of GDP are calculated from the GDP at market price estimates for Q3 FY 2008-2009 at current prices.

Agriculture, Forestry & Fishing 20.98%
Mining and Quarrying 2.53%
Manufacturing 14.79%
Electricity, Gas and Water Supply 1.52%
Construction 8.49%
Trade, hotels,transport and communication 24.40%
Financing, insurance, real estate and business services 13.60%
Community, Social and Personal Services 13.67%

What views do Michael Pettis and others censor?

2009-03-03T08:49:00.000-08:00

1) I expressed a view at Michael Pettis blog that China has, in fact bottomed out, when he wrote his essay on “Hooray! China has bottomed out” (which was a sarcastic title). Immediately, I was banned from the Michael Pettis blog! I didn’t even realize it for some time, but his website just wouldn’t load on my system. I thought this was because of some temporary problem with his site. Then one day I tried loading his site from other systems and it was perfectly accessible.And note that I hardly made 2-3 comments in all at Pettis’ and none of them had anything with good or bad manners.
2) At Paul Krugman’s blog on the New York Times web site, I pointed out that nationalizing US banks can make unfriendly foreign governments nationalize the overseas subsidiaries of those banks. Prior to making this comment, my comments - again, very few - would appear as ” awaiting moderation” by default. Some of them would later get approved and published or not; but all of them on my upload would appear as "awaiting moderation". After I uploaded this view on bank nationalization, I no longer see my uploaded comments pending moderation at Krugman’s New York Times blog.
Both of these illustrate to me that I’m touching on topics that are perhaps too sensitive. Pettis probably has an agenda to propagandize against the Chinese exchanges rising, and Krugman to demand nationalization of banks. Though I’m just an individual investor my views were too controversial to be allowed on those sites.
In Setser’s case it appears to me that the objection is from the Council on Foreign Relations mandarins, and less from Setser; though again I could be wrong.
In any case, one thing I’m very sure of is that my particular IP has been pinpointed and banned by Pettis.
Update: I've edited this post to reflect that Paul Krugman writes for the New York Times, so the newspaper might be exercising at least as much control over content at his blog as he does. This insight is based on the comment below.

Brad Setser Censors pro-equities comments

2009-03-03T06:45:00.000-08:00

Dr. Brad Setser runs a propaganda blog where the main point is something that goes like:
1) There can't free trade, there can only be 'balanced trade'.
2) Even if the US dollar is just a legal tender currency, China accumulates US dollars in lieu of gold, in a mercantilist manner.
3) Countries use money to 'finance the current account deficit', even when they're spending it mainly on military contracts.
Here are some objectives views about markets; these are just a small subset of various opposite views that have been censored by Dr. Setser. Since Setser runs a propaganda blog, he can't afford to have views opposing his malinterpretations gain traction at his blog page.
The Nifty peak was around 6300 in 2008, and its trough was at 2500 which was hit in October and then again in November after a dead cat bounce. The Q3 FY 2008-2009 results didn’t lead to fall below the October lows. Today’s Sensex close is lower than its October low and the Nifty is a few percent above 2500 because of different weightages.What caused the fall from 6300 to 2500? India’s exports, both merchandise and services have fallen. Imports, on the other hand have been rising, especially fertilizer and capital equipment.The real reason for the Nifty fall was that FIIs steadily sold out each month in 2008, while Domestic IIs were net buyers each month. The last two days’ fall is also a result of massive FII outflows.The INR/USD has shown a strengthening of USD against INR. Private sector banks like ICICI have something like 50% of their borrowings abroad. That has been unwinding, and not rolled over. Add up the effect of not rolling over foreign currency loans, and a sell-off of FII holdings in local equities; In my humble opinion, that explains much more of the fall in equities and weakening of the INR than a fall in real economy exports, etc.I’m expecting a functioning credit system to emerge in the US, which will lead to the reverse of the above flows.Outstanding credit has been growing in India, just as it has been in China. India is an exception to the theory that emerging markets grew mainly through exports, especially exports to the US.India’s external sector has been making a net negative contribution to GDP, while the GDP has been growing at 8-9%. While falling exports will have a negative effect, India’s GDP growth wasn’t ‘export-led’ by comparable standards.Also, this should make you think about the component of China’s growth that came from domestic expansion, though China does have a much larger share of exports in GDP, and a sizeable trade surplus, justifying the notion that exports contributed a lot to China’s GDP growth.All this doesn’t mean that India is shining. The policy makers in every country give statistical nostrums to the people. In a country with millions of uneducated or undereducated people; an agricultural sector that depends on rainfall because of the government’s inability to dig irrigation channels;etc … Consider an African American who is now paid 5 cents a day in addition to food and shelter because Lincoln abolished slavery. When his income grows to 6 cents a day over 5 years, his macroeconomy has grown 8% percent over those years!

Can Paul Volcker get away with talking nonsense at Canadian bankers?

2009-02-28T18:02:00.000-08:00

The short answer seems to be, yes.
Here's an excerpt from a Paul Volcker speech:
"This phenomenon can be traced back at least five or six years. We had, at that time, a major underlying imbalance in the world economy. The American proclivity to consume was in full force. Our consumption rate was about 5% higher, relative to our GNP or what our production normally is. Our spending – consumption, investment, government — was running about 5% or more above our production, even though we were more or less at full employment.
You had the opposite in China and Asia, generally, where the Chinese were consuming maybe 40% of their GNP – we consumed 70% of our GNP. They had a lot of surplus dollars because they had a lot of exports. Their exports were feeding our consumption and they were financing it very nicely with very cheap money. That was a very convenient but unsustainable situation. The money was so easy, funds were so easily available that there was, in effect, a kind of incentive to finding ways to spend it."
Is Paul Volcker reasoning accurately here? Suppose, for instance, that Indians acquire an increased penchant for importing more and more electronic gadgets from China. And China decides to buy a lot of Government of India securities to artificially strengthen the Indian Rupee. How would this turn out? The FRBM target is to reduce the fiscal deficit to around 3% by next year. As long as the Government maintains a strong fiscal path, and spends in tune with its income; it wouldn't matter whether the G-Secs are held by locals or foreigners; or the People's Bank of China.
PBoC INR denominated forex reserves would in this example strengthen the INR artificially, and that will make life easy for Indian consumers of China's electronics. But as long as the Government finances are strong, we would never go bust as a result of consuming those electronics at those cheap prices. In fact, the more the PBoC buys INR securities, the happier we would have been at this free Chinese giveaway of their electronics.
Paul Volcker is diverting attention from the simple fact that it was the US Treasury that borrowed huge amounts, far in excess of its income, and spent it on various items. The US Treasury is directly responsible for this whole mess. And by having these kinds of speeches, they're proceeding in the direction of more and more Government debt, rather than less, creating a dangerous situation where the Sovereign itself can be forced into default.
Here's the full speech: (I got it from a comment posted at Brad Setser's blog)
I really feel a sense of profound disappointment coming up here. We are having a great financial problem around the world. And finance doesn’t work without some sense of trust and confidence and people meaning what they say. You take their oral word and their written word as a sign that their intentions will be carried out.
The letter of invitation I had to this affair indicated that there would be about 40 people here, people with whom I could have an intimate conversation. So I feel a bit betrayed this evening. Forty has swelled to I don’t know how many, and I don’t know how intimate our conversation can be. But I will, at the very least, be informal.
There is a certain interest in what’s going on in the financial world. And I will disappoint you by saying I don’t know all the answers. But I know something about the problem. Let me just sketch it out a little bit and suggest where we may be going. There is a lot of talk about how we get out of this, but I think it’s worth remembering, or analyzing, how this all started.
This is not an ordinary recession. I have never, in my lifetime, seen a financial problem of this sort. It has the makings of something much more serious than an ordinary recession where you go down for a while and then you bounce up and it’s partly a monetary – but a self-correcting – phenomenon. The ordinary recession does not bring into question the stability and the solidity of the whole financial system. Why is it that this is so much more profound a crisis? I’m not saying it’s going to get anywhere as serious as the Great Depression, but that was not an ordinary business cycle either.
This phenomenon can be traced back at least five or six years. We had, at that time, a major underlying imbalance in the world economy. The American proclivity to consume was in full force. Our consumption rate was about 5% higher, relative to our GNP or what our production normally is. Our spending – consumption, investment, government — was running about 5% or more above our production, even though we were more or less at full employment.
You had the opposite in China and Asia, generally, where the Chinese were consuming maybe 40% of their GNP – we consumed 70% of our GNP. They had a lot of surplus dollars because they had a lot of exports. Their exports were feeding our consumption and they were financing it very nicely with very cheap money. That was a very convenient but unsustainable situation. The money was so easy, funds were so easily available that there was, in effect, a kind of incentive to finding ways to spend it.
When we finished with the ordinary ways of spending it – with the help of our new profession of financial engineering – we developed ways of making weaker and weaker mortgages. The biggest investment in the economy was residential housing. And we developed a technique of manufacturing class D mortgages but putting them in packages which the financial engineers said were class A.
So there was an enormous incentive to take advantage of this bit of arbitrage – cheap money, poor mortgages but saleable mortgages. A lot of people made money through this process. I won’t go over all the details, but you had then a normal business cycle on top of it. It was a period of enthusiasm. Everybody was feeling exuberant. They wanted to invest and spend.
You had a bubble first in the stock market and then in the housing market. You had a big increase in housing prices in the United States, held up by these new mortgages. It was true in other countries as well, but particularly in the United States. It was all fine for a while, but of course, eventually, the house prices levelled off and began going down. At some point people began getting nervous and the whole process stopped because they realized these mortgages were no good.
You might ask how it went on as long as it did. The grading agencies didn’t do their job and the banks didn’t do their job and the accountants went haywire. I have my own take on this. There were two things that were particularly contributory and very simple. Compensation practices had gotten totally out of hand and spurred financial people to aim for a lot of short-term money without worrying about the eventual consequences. And then there was this obscure financial engineering that none of them understood, but all their mathematical experts were telling them to trust. These two things carried us over the brink.
One of the saddest days of my life was when my grandson – and he’s a particularly brilliant grandson – went to college. He was good at mathematics. And after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, “I want to be a financial engineer.” My heart sank. Why was he going to waste his life on this profession?
A year or so ago, my daughter had seen something in the paper, some disparaging remarks I had made about financial engineering. She sent it to my grandson, who normally didn’t communicate with me very much. He sent me an email, “Grandpa, don’t blame it on us! We were just following the orders we were getting from our bosses.” The only thing I could do was send him back an email, “I will not accept the Nuremberg excuse.”
There was so much opaqueness, so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events only happen once every hundred years. But we have “once every hundred years” events happening every year or two, which tells me something is the matter with the analysis.
So I think we have a problem which is not an ordinary business cycle problem. It is much more difficult to get out of and it has shaken the foundations of our financial institutions. The system is broken. I’m not going to linger over what to do about it. It is very difficult. It is going to take a lot of money and a lot of losses in the banking system. It is not unique to the United States. It is probably worse in the UK and it is just about as bad in Europe and it has infected other economies as well. Canada is relatively less infected, for reasons that are consistent with the direction in which I think the financial markets and financial institutions should go.
So I’ll jump over the short-term process, which is how we get out of the mess, and consider what we should be aiming for when we get out of the mess. That, in turn, might help instruct the kind of action we should be taking in the interim to get out of it.
In the United States, in the UK, as well – and potentially elsewhere – things are partly being held together by totally extraordinary actions by a central bank. In the United States, it’s the Federal Reserve, in London, the Bank of England. They are providing direct credit to markets in massive volume, in a way that contradicts all the traditions and laws that have governed central banking behaviour for a hundred years.
So what are we aiming for? I mention this because I recently chaired a report on this. It was part of the so-called Group of 30, which has got some attention. It’s a long and rather turgid report but let me simplify what the conclusion is, which I will state more boldly than the report itself does.
In the future, we are going to need a financial system which is not going to be so prone to crisis and certainly will not be prone to the severity of a crisis of this sort. Financial systems always fluctuate and go up and down and have crises, but let’s not have a big crisis that undermines the whole economy. And if that’s the kind of financial system we want and should have, it’s going to be different from the financial system that has developed in the last 20 years.
What do I mean by different? I think a primary characteristic of the system ought to be a strong, traditional, commercial banking-type system. Probably we ought to have some very large institutions – or at least that’s the way the market is going – whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system.
This kind of system was in place in the United States thirty years ago and is still in place in Canada, and may have provided support for the Canadian system during this particularly difficult time. I’m not arguing that you need an oligopoly to the extent you have one in Canada, but you do know by experience that these big commercial banking institutions will be protected by the government, de facto. No government has been willing to permit these institutions, or the creditors and depositors to these institutions, to be damaged. They recognize that the damage to the economy would be too great.
What has happened recently just underscores that. And I think we’re at the point where we can no longer fool ourselves by saying that is not the case. The government will support these institutions, which in turn implies a closer supervision and regulation of those institutions, a more effective regulation than we’ve had, at least in the United States, in the recent past. And that may involve a lot of different agencies and so forth. I won’t get into that.
But I think it does say that those institutions should not engage in highly risky entrepreneurial activity. That’s not their job because it brings into question the stability of the institution. They may make a lot of money and they may have a lot of fun, in the short run. It may encourage pursuit of a profit in the short run. But it is not consistent with the stability that those institutions should be about. It’s not consistent at all with avoiding conflict of interest.
These institutions that have arisen in the United States and the UK that combine hedge funds, equity funds, large proprietary trading with commercial banks, have enormous conflicts of interest. And I think the conflicts of interest contribute to their instability. So I would say let’s get rid of that. Let’s have big and small commercial banks and protect them – it’s the service part of the financial system.
And then we have the other part, which I’ll call the capital market system, which by and large isn’t directly dealing with customers. They’re dealing with each other. They’re trading. They’re about hedge funds and equity funds. And they have a function in providing fluid markets and innovating and providing some flexibility, and I don’t think they need to be so highly regulated. They’re not at the core of the system, unless they get really big. If they get really big then you have to regulate them, too. But I don’t think we need to have close regulation of every peewee hedge fund in the world.
So you have this bifurcated – in a sense – financial system that implies a lot about regulation and national governments. If you’re going to have an open system, you have got to get much more cooperation and coordination from different countries. I think that’s possible, given what we’re going through. You’ve got to do something about the infrastructure of the system and you have to worry about the credit rating agencies.
These banks were relying on credit rating agencies while putting these big packages of securities together and selling them. They had practically – they would never admit this – given up credit departments in their own institutions that were sophisticated and well-developed. That was a cost centre – why do we need it, they thought. Obviously that hasn’t worked out very well.
We have to look at the accounting system. We have to look at the system for dealing with derivatives and how they’re settled. So there are a lot of systemic issues. The main point I’m making is that we want to emerge from this with a more stable system. It will be less exciting for many people, but it will not warrant – I don’t think the present system does, either — $50 million dollar paydays in that central part of the system. Or even $25 or $100 million dollar paydays. If somebody can go out and gamble and make that money, okay. But don’t gamble with the public’s money. And that’s an important distinction.
It’s interesting that what I’m arguing for looks more like the Canadian system than the American system. When we delivered this report in a press conference, people said, “Oh you mean, banks won’t be able to have hedge funds? What are you talking about?” That same day, Citigroup announced, “We want to get rid of all that stuff. We now realize it was a mistake. We want to go back to our roots and be a real commercial bank.” I don’t know whether they’ll do that or not. But the fact that one of the leading proponents of the other system basically said, “We give up. It’s not the right system,” is interesting.
So let me just leave it at that. We’ve got more than 40 people here but they’re permitted to ask questions, is that the deal?

Brad Setser's "China Yoke" Theory - replete from direct quotes

2009-02-27T22:52:00.001-08:00

Here’s one link to Brad Setser’s analysis on what led to the ongoing crisis:
According to Brad Setser, the People's Bank of China encouraged Americans to "turn a home into an ATM":
“Absent a large savings surplus in Asia and the oil exporters, rising US rates would have choked off the housing bubble much earlier. High long-term rates aren’t conductive to rising home prices — and without rising home values it is hard to turn a home into an ATM.…Central banks reserve growth in the savings surplus countries carried this surplus to the US. … The process that led to the boom in risky assets was indirect: Central bank demand for safe assets drove down the return on safe assets and encouraged private sector risk taking. Private banks, famously, didn’t want to sit out the dance.”
APART from blaming the PBoC for the mortgage boom (you need to closely follow each of his essays to know that he’s actually referring mainly to the PBoC in the above paragraphs) Brad Setser also blames the United States Public Debt on imports from China here:
“Remember this the next time someone argues that the US will be borrowing more from the rest of the world to finance its fiscal deficit: the total amount the US borrows from the world is defined by the current account deficit and the current account deficit clearly went down in the fourth quarter even as the US fiscal deficit (and the Treasury’s borrowing need) soared.”
Here Brad Setser revises economic history by claiming that the excessive lending by private banks that weren’t regulated properly by the Federal Reserve was actually a result of China’s exchange rate policy. Excerpts:
“By holding US interest rates down and the dollar up, China’s policies discouraged investment in tradables production in the US while encouraging investment in the interest-rate sensitive sectors that weren’t competing with Chinese production. This isn’t too say that the US didn’t already have a slew of policies in place to encourage investment in housing. It did — from the Agencies to ability to deduct mortgage interest from tax payments. But the surge in demand for US bonds from the world’s central banks reinforced those policies.…More money was allocated to home construction (for a time) and less to investment in the production of goods for export than otherwise would have been the case.…Those who attribute the growth of the past several years solely to the market miss the large role the state played in many of the world’s fast growing economies. Conversely, those who attribute all the excesses of the past few years to the market miss the role that governments played in financing many of those excesses …”
Me: So you see, Brad Setser also blames China for the fact that there wasn’t much investment in industrial production facilities in the US the last several years. Either you need to follow Brad Setser’s “China Yoke” theory of the crisis, or get down to brasstacks and fix some simple lending norms for retail loans in the US to prevent this sort of thing from happening again.

My Comments and views censored by Dr. Brad Setser (the latest set)

2009-02-26T20:05:00.000-08:00

Following is a set of comments I posted on the blog page of Dr. Brad Setser. They have been deleted and now I'm pasting them here so anybody who's interested can read them here.

Here's Brad' Setser's advocacy on financing US Treasuries from a small private cartel instead of the PBoC

Brad Setser:That implies, if the Pandey/Setser estimates for official purchases are right, that private investors snapped up more Treasuries than the world’s central banks…My guess is that the Treasury market will be driven by developments in the US – not developments in China – in 2009.
Me:What will any reasonably smart, thinking person, think when they read this?
When we discussed how China’s purchase of Treasuries affects the $11 trillion home mortgage boom, we reasoned how flows matter. Mostly, the $11 trillion boom was fueled by flows from China’s Treasury purchases.Now we’re looking at the impact of China’s Treasury purchases on the market for Treasuries itself - and we aren’t seeing much of an impact there.
Most of those smart people who’re thinking this will also type in that you’ve made a great, wonderful analysis, and never raise this point. Some of them might actually even cheerlead your post here.

Let’s hope private market participants don’t bet on high Treasury Bond prices now. Jansen’s post suggests the classic rupture of Government Bond prices. Central Bank demand for Treasuries remained high on the day he reports on, yet prices crashed and yields rose. This is very good news for equity markets and home prices.People are clearly demanding higher yields now.

Here are some comments I made in response to comments from other blog participants:
@ KT Cat - can you consider not interpreting things as “horrible”,”dreadful”, and “shrinking” without more reasoning than you present above?
Banks are trying to dispose of a large set of foreclosed homes together, say, in a block worth around $30 million, to small groups of private investors. Sales volumes are a bit down because these negotiations take more time than a fire sale.Banks are also disposing of foreclosed properties in some areas individually; that typically goes faster.
Lower demand for Treasuries at higher Treasury prices is again very good news for the US economy.
I don’t understand what you mean by“Japan’s economy is getting killed”.
I explained yesterday that Japan’s exports and imports are down more than China’s because of lesser credit growth in the Japan economy than China, but Brad deleted my post.Once the credit problems are solved things will be much better for Japan.

jim:…they invest on fundamental strengths that are dominating the market place …
Me: Fundamental analysis based on earnings, etc in my opinion is like a relative grading system. You can put a buy,hold or sell recommendation on a particular equities by comparing them with others. The underlying assumption is that your analysis is largely to allocate a certain fixed amount of capital amongst different equities. You can also account for the differential impact of macroeconomic or other ‘market risk’ events on different equities.But in terms of determining the overall direction of indices, that part of fundamental analysis isn’t particularly useful. It’s not easy to discount future cash flows, arrive at a fixed number for the ‘present value’ of the stock and use that as a basis to be a successful investor. Your ‘present value’ rarely ties in with the market’s, especially with wide fluctuations in multiples. It’s best to recognize that, even by the conceptualization of capital market theory, market risk can at best be diversified away to reduce its impact,not eliminated. Successful investment therefore requires understanding the full spectrum of fundamental analysis, macroeconomic analysis and most importantly, the geopolitical underpinnings of international finance.Earnings are definitely weak in US equities and will probably grow slowly for some time. But the reason to go long is a market bottom, a shift in the debate to when things will get better, from how much worse things will get before they get better.Of course my actual strategy is long in the Nifty, and not the Dow, and the two things are quite different.Nomura Holdings recently hired 50 team leads with long expertise in US equities and they’re rapidly setting up a sizeably large US equities unit. If they don’t have plans to invest in US equities, or advise clients to do so, these hiring decisions wouldn’t be rational.

@DOR: Residential investment in the US was at levels of $600+ billion, out of a $14 trillion economy, even at inflated prices.The direct output effect of a collapse in residential investment is small. The US was perhaps just as much of a Hollywood Economy, rather than a Home Building Economy during the boom.That would be consistent with a 43% share of services in GDP.Home Equity Withdrawals financed 3-4% of PCE. Annual increases in o/s consumer credit were 1% of GDP.US consumption wasn’t mainly driven by using homes as ATMs,though that conceptualization is attractive.35% of US homes were owned outright in 2007. 5% of the remaining 65% homes had mortgages that were both ARMs and subprime. The mythical American risky borrowers were therefore few.The recent collapse can be explained by the non availability of normal credit. For instance, even qualifying home buyers may not get a mortgage loan. People with a good income and finances may not get approved for a car loan. Similarly, difficulties in segments like student loans, corporate working capital loans, export credit, letters of credit, etc have disrupted the US economy.A certain level of credit is neither good or bad by itself, but only in comparison with income and overall balane of assets and liabilities. Once normal credit flows are re started, things will be much better for the US economy.But growth will be slow because the destruction of personal net worth due to fall in home prices needs to be worked off by US consumers.

A few (seemingly forgotten) basic characteristics of the US economy

2009-02-20T01:19:00.000-08:00

1) The US economy is more of a services economy than a products economy.In 2008, services totaled $ 6139.8 b out of the GDP of $14264.4 b, which is 43.04% of GDP.Durable goods were $ 944.40 b and non durable goods were $ 2846 b, giving a total of only 26.57% of GDP for goods altogether.
2) Services exports from the US are more than services imports, and the US has a trade surplus in the services category.Services exports were $551 b and imports were 407 b, giving a surplus of $144 b or so, which tho isn;t a major percentage of GDP.
3) Trade deficit is a small percentage of GDP for the US: The overall trade deficit including goods and services was $ 529 b in 2008 (according to above NIPA tables). (I noticed another table in which the non seasonally adjusted balance for 2008 overall is -$677 b). Overall, the US trade deficit is only 3.71% of GDP.
4) The goods deficit is insignficant in comarison to the total size of the US economy. For 2008, the goods deficit is around $ 821 b, which is around 5.76% of the US economy.
5) In 2008, Government consumption expenditures and gross investment (including Federal, State, local, defense, etc) totaled $ 2914.9 b. The US Government is therefore ~20.43% of the US economy.
Link to BIPA tables

Anlaysis of US Consumer Credit Growth - Thank Paul Swartz

2009-02-19T01:05:00.000-08:00

Here’s another essay from Paul Swartz at Brad Setser’s blog analyzing recent changes in US consumer credit from the Fed’s g19 release.
Following is my comment on the Q4 2008 consumer credit levels:
In the g19 release, it’s clear that absolute total consumer credit o/s. contracted from $2585.3 billion in October 2008 to $ 2582.6 billion in November 2008. Then, in December 2008, it increased to $ 2596.0 billion. So I think Paul’s interpretation that consumer credit grew after the TARP I funds sank in, albeit slowly, is correct.The summary at the top of the Fed’s g19 release probably deals with decreases at ‘annual rate’; which might be some statistical measure other than the absolute o/s numbers in Q4 ‘08.
Personal Consumption Expenditure levels in the United States between 2004 and 2008, according to the National Income and Product Tables from BEA:
2005 $8,893.70
2006 $9,357.00
2007 $9,892.70
2008 $9,930.20
The total PCE 2005-2008 was $38,073.60 billion.
From the Fed’s g19 release linked above, total consumer credit outstanding grew from $2191.60 billion at the end of 2004 to $2562.30 at the end of 2008, an increase of $ 370.70 billion. Increases in consumer credit funded only 0.97% of total US PCE between 2005 and 2008.
Here's a link to the Fed’s Flow of Funds release for reference to the general credit growth data for all sectors.

Revisting the Yen Carry Trade Mechanics

2009-02-18T14:20:00.000-08:00

At this post on Brad Setser's blog in February 2007, you see an interesting discussion of the yen carry trade size and mechanics, which I’m re producing below. (The content is from the RGE monitor web site)

Andrew Rozanov of State Street knows a thing or two about how official institutions manage their money (that is a big part of his current job) and a thing or two about Japan (he was based in Tokyo for some time). In response to my previous post, he noted that much of the yen carry trade is now done through the swaps market – or off balance sheet. Hedge funds don’t really need to “borrow” yen and then buy higher yielding currencies – they do the same thing in the derivatives market, or pay a bank to do it for them. I have – with his permission – reprinted his comment below. It inspired a nice discussion.
UPDATE: State Street also seems to know a thing or two about the size of the carry trade. See the FT.
I took a number of things away from the discussion:
1) The obvious, what happens off balance sheet matters. The absence of strong growth in cross-border yen lending isn’t evidence that folks aren't betting on continued yen weakness – or that interest rate differentials will remain large enough to offset any uptick in the yen.
2) A trillion is probably a bit too high an estimate of the size of the yen carry trade, at least if we are talking about bets from the “leveraged” hedge fund community.
3) We shouldn’t forget about leveraged Japanese day traders … who, in aggregate, have become big players. Fx accounts with generous margin are the rage in Tokyo.
4) It is hard for competitive money managers to be on the sidelines and avoid putting on various kinds of carry trades right now.
Andrew Rozanov writes:
“as volatility remains low and carry keeps being profitable, for a commercially driven fund management shop it is becoming more and more painful to stay away from these trades, certainly if you are in competition with others in raising money from investors. Just plot the returns from a simple carry basket on Bloomberg's FXIP (I suggest using long GBP at 50% and long EUR at 50%, while short JPY 50% and short CHF 50%) -- and then look at the statistics below for one-year return, volatility and the Sharpe ratio. They are phenomenal! And what do investors more often than not look for when comparing and choosing hedge fund managers? Why, high and stable returns at relatively low volatility - strategies with very high Sharpe ratios! Never mind the higher moments and fat tails...”
I would note that volatility is also low for some emerging market currencies. Volatility in the Brazilian real/ dollar, for example, has collapsed – because the central bank has resisted market pressure for further appreciation in the real. The same thing incidentally happened in Turkey in 2005. Low observed volatility makes the real-denomianted carry trade even more attractive. And that pulls in even more money. It probably isn’t an accident that Brazil added over $5b to its reserves in January. There are a lot of different cross-currency carry trades out there that have attracted a lot of attention.
Andrew Rozanov’s comments are reprinted in full below
Andrew Rozanov:
I would like to commend those astute commentators who pointed out the direct relevance and central role of the forward currency swaps market in facilitating carry trades. It is arguably the easiest and most preferred method to put on a 'carry trade' by the leveraged community. It was described several years ago in a book written for a Japanese audience by a former Moore Capital trader, Ken Shibusawa, who currently runs his own hedge fund advisory firm in Tokyo (Japanese website for his company: http://www.shibusawa-co.jp/index.html). According to him, essentially the press has got it all wrong. Yes, the underlying economics of a typical carry trade is to 'borrow' in low-yielding currency (e.g. the yen) and then 'lend' on in higher-yielding currency (e.g. the dollar), but when we discuss the actual mechanics of it, hedge funds and other highly leveraged players typically would not engage in any actual borrowing or lending. To the extent a hedge fund would consider putting on such a trade at all, it would most likely do it in the following way, or some variation thereof (we use US$/JPY levels as in Ken Shibusawa's example in the Japanese book): Step 1. Buy US$ / Sell JPY in the spot market (say, at 120) Step 2. Buy JPY/ Sell US$ in the spot market (again, at 120) Step 3. Buy US$ at a discount / Sell JPY at a premium in the forward market (say, 3 months forward at 118.50) Step 4. Buy UST in the spot market Step 5. Borrow US$ against UST in the repo market Some comments are in order. 1. A typical currency forward swap is step 2 + step 3. However, if that's all you do, you will be expected to deliver your US$ for settlement on T+2. But remember, we are looking at a hedge fund, who does not have the money to deliver and who wants leveraged carry. Thus, he needs to create this exposure with as little initial cash outlay as possible. The best way to do that would be to take an outright forward position in the market. 2. An astute observer will have noticed that the cumulative effect of steps 1 through 3 is precisely to create such an outright forward position, whereby our hypothetical hedge fund is now short the yen and long the dollar at 118.50 on a 3-month horizon (in other words, the hedge fund promised to pay 118.50 in 3 months time for an asset which is currently trading at 120 - and the lower the US$/JPY volatility, the higher the chance that the forward contract will have converged at or around the original spot price of 120). 3. But if a hedge fund wants an outright forward position, why go through the hassle of steps 1-3? Well, it all has to do with costs and liquidity. Apparently, it is cheaper and easier to put on such a position in the currency swap market rather than as an outright forward - as the market supporting corporate and 'real money' hedging activity, it is the most liquid. 4. Notice how the trade is structured in two separate legs. There is the FX market leg, where the hedge fund puts on a position to earn the carry from the interest rate differential in the two short-term markets. Then there is the UST leg, which is a completely separate transaction: longer duration US Treasuries are purchased to earn a higher yield, but they are financed in the repo market (of course, this example assumes a 'normal' upward sloping yield curve in the US). So if (and it IS a huge if) all goes as planned in the US$/JPY and UST markets, the total carry earned on the trade is the sum of FX market carry (i.e. short term interest rate differential) and UST market carry. Another way of putting it: the hedge fund earned money from two major risk sources: currency mismatch risk and duration mismatch risk. 5. In his book, Ken Shibusawa makes an interesting observation: many press commentators focus on what they can trace in the spot markets (i.e. step 1 and step 4), and often do not pick up on simultaneous transactions in derivative markets (i.e. combination of step 2 & 3, step 5). Thus, the tendency is to interpret this as hedge funds borrowing yen and selling yen spot, thus procuring dollars and then investing these dollars in long maturity UST). While the underlying economic logic and principle is the same, the mechanics are totally different. 6. Ken Shibusawa quips in the book that while much press attention at the time was focused on global macro hedge funds, it was probably relative value shops that were particularly keen on putting on massive yen carry trades in 1997-98, following the relative success of their "Japan risk premium" carry trades in the previous years. One final comment from me: as volatility remains low and carry keeps being profitable, for a commercially driven fund management shop it is becoming more and more painful to stay away from these trades, certainly if you are in competition with others in raising money from investors. Just plot the returns from a simple carry basket on Bloomberg's FXIP (I suggest using long GBP at 50% and long EUR at 50%, while short JPY 50% and short CHF 50%) -- and then look at the statistics below for one-year return, volatility and the Sharpe ratio. They are phenomenal! And what do investors more often than not look for when comparing and choosing hedge fund managers? Why, high and stable returns at relatively low volatility - strategies with very high Sharpe ratios! Never mind the higher moments and fat tails...

And, for those of us without the financial sophistication to understand why anyone would both buy US$ for yen and sell US$ for yen in the spot market, Andrew noted:
Let me try and answer your question about why go through steps 1 and 2 by considering the other options. 1. If you do only step 1, you are going long USD and short JPY in the spot market. There are two problems with this approach as far as leveraged carry trades go. First, it's not leveraged - you will need to come up with the entire notional amount of JPY to settle this trade in two working days (T+2), so you're not really 'borrowing' anything. Secondly, you're not really trading for carry. Instead, you're putting on a directional bet: you buy US$ at 120 and hope it appreciates (or JPY depreciates), but you're not picking up any interest rate differentals. Incidentally, this type of trade typically favours high volatility environment - remember, volatility cuts both ways, so if you want to make money from a large swing up in the dollar (or swing down in the yen), you would be implicitly betting on high, not low vol. Carry trades, on the other hand, are typically low vol trades: any additional depreciation of the yen would be icing on the cake, but your main bet is that the world stays stable and predictable while you earn your carry on a leveraged basis (i.e., interest rate differential multiplied by leverage). 2. What about taking only steps 2 and 3 - i.e., the foreign exchange swap? The good news is this gives you carry: you buy 120 yen for every dollar now (on T+2) and at the same time contract to sell the newly acquired yen in 3 months' time, such that 118.50 buys you a dollar - in other words, you sold the dollar now at 120 and bought it back in 3 months at 118.50, earning the carry in the process. But the bad news is that, just like in the first comment above, you do not get any leverage, since you will need to provide an initial cash outlay on T+2 to settle the leg in step 2. 3. Why not forget steps 1 and 2 altogether, and just go for step 3? This is entirely legitimate and certainly doable. In the FX market, such a transaction is called an 'outright forward'. You agree with your counterparty bank to go long USD and short JPY based on today's spot price, but with settlement in 3 months' time - you will negotiate and agree the spot price, and then the bank will adjust it by the interest rate difference. No cash flows occur on T+2, you have effectively secured a leveraged position, and you've bought US$ at 118.50 in 3 months. Voila! The only reason you would consider doing something a bit more convoluted (like going through steps 1 to 3 above) is if it helps you save costs and earn even more money. And in competitive markets like FX you get the best prices and execution where the liquidity is the deepest. And the liquidity of spot and FX swap markets has always been (and I believe still is) much better and deeper than in the outright forward markets. Just have a look at Table B1 on page 5 of the BIS Triennial Central Bank Survey at the following link (last survey done in 2004): http://www.bis.org/publ/rpfx05t.pdf
Hellasious and Tmcgee also chimed in; Hellasious noted the growth in outstanding yen forwards. Tmcgee argued that these are notional numbers, so they only give a loose idea of real exposure. He also noted the role of Japanese fx margin traders – something that the FX team at Citi also likes to highlight.

Hellasious and Tmcgee also chimed in; Hellasious noted the growth in outstanding yen forwards. Tmcgee noted that these are notional numbers, so they only give a loose idea of real exposure and noted the role of Japanese fx margin traders – something that the FX team at Citi also likes to highlight.
Hellasious:
I urge everyone to visit the BIS site and look up the relevant FX forward data for yen. The amounts have jumped very substantially from $2.3 trillion to $3.8 in 5 years. A big part of the increase has come in just 6 mos., going from $3.1 to $3.8 trillion between Dec. 2005 and June 2006 (latest available data).
Tmcgee cautioned:
I think $1 trln is a slightly ridiculous number, even if you include the sheer Japanese foreign asset holdings that don't really constitute carry trades per se, just a hunt for higher yields. Also, the BIS derivatives data gives some clues on potential size of carry trades. But I believe they also are all notional numbers, like the US OCC data, which means they're always growing at a fairly rapid pace -- because both sides of the trade are counted. The funny thing is now people are freaking about the size of the carry trade even though one of the supposed culprits of the unwinding of carry trades last april/may (incorrectly) -- a drop Japan's monetary base from the BOJ ending quantitative easing -- is still shrinking 21% yr/yr. and other BIS data -- reporting banks' cross-border positions vis-a-vis all sectors, by domestic and foreign currency -- shows no explosion of yen liabilities among major global banks.
Reporting bank yen cross-border positions vis-a-vis all sectors (blns USD) liabilities:
Domestic currency: December 04: $240.9; Sept 06: $235.9Foreign currency : December 04 $433.1; Sept 06 $457.6 We know the IMM speculative yen short data, so we have a vague since carry trades are popular. But as the Wachovia anlaysis points out, the evidence is far from compelling. ….
Also, no one seems to mention the role of Japanese FX margin trades in the carry trade. Check out data from the Tokyo Financial Exchange, which gives just a small peek into the explosion of margin trading here. These margin traders are quick to take profits when cross/yen hits new highs, but also buy the higher-yielding currencies (like the Aussie, on serious leverage) on any sharp pull-backs. And since so much money is waiting in Japan for moments of yen strength to invest abroad, it tends to put a floor under not only dollar/yen, but also euro/yen and sterling/yen …
BSetser edits: Data presentation edited for clarity, punctuation added.
And Cassandra always has a thing or two to say about the yen and yen carry trades.
Even if Tmghee is right and total carry trade exposure is significantly under $1 trillion, it scale of the carry trade seems to have increased significantly recently. And a lot depends on how the capital outflow from real money Japanese accounts over the past few years should be interpretted. Is it international diversification, money that is unlikely to return to Japan should relative interest rates change and/ or the yen start to appreciate? Or is it a bit more fickle, and perhaps be inclined to act a bit like leveraged money should conditions change?
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Comments
In the FX forward swaps market there are no "notional" amounts. All amounts are real and outstanding. If you put on a dollar/yen swap trade for $100 million you have to deliver $100 million in cash and receive the equivalent in yen, in cash, on spot settlement date. When the forward date comes, you will return the yen and receive back the dollars, again real money flows. This is not an option or futures trade, but a real swapping of large amounts of money. The amounts outstanding are thus very important and indicative.
Reply to this comment By Hellasious on 2007-02-04 16:32:32
hellasious -- would you mind if i made use of your comments on the preceding post in this post? My sense was that tmghee was arguing that "notional" amount may not reflect the banks ultimate risk -- take an example I happen to know well. Turkish banks were keen (in 05) to swap $ for long-term lira. International investors took a generally unhedged lira position in this swap (the banks that did the swap did so more their hedge fund clients ... who wanted more lira duration than was available in the government bond market). The turkish banks had $ to swap from their domestic dollar deposits so they were hedged, and they used the swaps to finance a fraction of the long-term mortgage lending. So the turkish banks effectively had offset both legs of the swap -- they had $ and long-term lira liabilities on balance sheet, and they used the offbalance sheet swap to match the two. that may nor may not be relevant here -- i generally know more about how folks manage their EM exposure than about stuff among the g-10.
Reply to this comment By bsetser on 2007-02-04 17:23:12
Dear Brad, You are welcome to use any comments you find useful. The banks' ultimate risk may not be direct market risk, as such, but credit risk. Bank A's dealing room may be running a perfectly matched book, but a crucial question is who is on the other side of the trades. If other large banks, then they are 99% fine - but no one can make any money that way, of course. It would be as if a bookie laid every single bet he got against another reputable bookie, instead of running his own book. There are only two ways for a bank's dealing room to make money: taking proprietary positions for the bank's own risk (gambling) or taking advantage of customer flows to make a spread (acting as bookie). Under most circumstances, bank dealing rooms are not so much gamblers as bookies - they just want to make the vig. It is therefore crucial for them to pick their customers with care because, unlike the heavies, they cannot threaten their customers with permanent visits to the aquatic domain if they fail to make good on their losses. The phenomenal rise of hedge and private equity funds has increased the systemic appetite for risk - there are many more gamblers out there willing to bet and that is why, pari pasu, the price of risk has collapsed (low risk premiums). Many large banks, seeing an opportunity, have jumped in with "three feet": a) They act as bookies on more and larger bets (more vig). b) They loan margin money to their "prime" hedge fund and private equity customers to make more and bigger bets (loan sharking). c) They take advantage of large customer trade flows, trading along with them for their own account and risk (like a bookie betting alongside a large gambler). Obviously (b) generates more (a) - and that is where most of the risk resides. For as long as the customers keep winning the process generates huge and increasing fees, interest income and trading gains for the banks own P&L. But if, for whatever reason, gains become losses and the customers cannot meet margin calls then the downward spiral begins. Everyone can easily understand what this means. Even a cursory examination of how debt has exploded in the past few years, particularly that of the financial sector, points to serious leverage being responsible for pumping up all asset prices. The yen carry trade is but a part of this process. Regards
Reply to this comment By Hellasious on 2007-02-05 02:25:14
Call me dumb, but I still fail to see how doing step one and two will give any leverage? Assuming step one and two are equal and opposite (EaO) transactions, their aggregate effect will be 0 (in fact, less due to spread and internal processing costs). On T+2 I will still have both USD and JPY inflow and outflows (matching, assuming no spread). Transacting two EaO spot transactions and making money out of it seems to me like a financial perpetum mobile?
Reply to this comment By Guest on 2007-02-05 06:14:30
hey brad -- please feel free to use whatever you find helpful. and to andrew -- fair enough on the japanese household assets. i see that on the boj flow of funds data, the amount of household money in japanese investment trusts (mutual funds) rose 33.6% yr/yr as of sept 2006 to 59.68 trln yen ($493 bln at a Y121 rate), a record high. and most of the new growth is in foreign assets. so including such funds with that of margin traders (though still comparatively small), maybe $1 trln is not so far fetched. i just find the fears about the yen carry trade speculative fervor a bit far fetched, in part because there have been several shake-outs of such trades in the past two years to keep anyone holding such positions on their toes (and i'm talking purely in yen terms -- perhaps a wider basket of carry trades including yen/Swiss franc/etc helps protect such trades). on the BIS data, i'm still not sure. i can't see how the massive yen carry trade would elude such bank lending stats. which jibes in tokyo about the difficulties foreign banks have tapping the overnight call market at times, though that may just be the difference between on balance-sheet and off/OTC, as mentioned. what's also weird is how the gross market values of OTC FX derivatives have shrunk on the BIS data between 12/04 and 6/06 even as notional amounts have risen sharply. and the biggest risers notionally in percentage terms are the aussie and kiwi (+54.5% and +193%), and the yen at 34.4% even as the euro grew 29.0% and USD 23.5%. here's what the san francisco fed had to say about it: http://www.frbsf.org/publications/economics/letter/2006/el2006-31.html the BIS itself was more circumspect last year. i think the big fear is leverage. that's what 1998 was all about. i think there is leverage this time, but not nearly that severe. and there is a big japanese domestic story that explains the yen's weakness, that is getting branded a little too easily as the gigantic and potentially world-wrecking yen carry trade. cheers
Reply to this comment By tmcgee on 2007-02-05 07:15:20
Asian Central Banks attempt to combat Asset Bubbles http://www.bloomberg.com/apps/news?pid=20601089&sid=ajbIBdY0Pf7E&refer=china Not only did last year's higher interest rates fail to curb overinvestment, they may even have helped draw in all that cash. The People's Bank of China raised its benchmark rate twice last year; while higher rates kept consumer prices contained, they encouraged even more investment and growth by offering enhanced returns. China's M2, the broadest measure of money supply, rose 16.9 percent to 34.6 trillion yuan ($4.46 trillion) in December, the highest since figures became available in June 1998. In Thailand, M2 in November reached a record 6.92 trillion baht ($197 billion). China's rate increases last year failed to cool an investment boom that stoked the fastest growth since 1995. The central bank also increased the amounts banks have to set aside as reserves four times since June to discourage excessive lending. That helped slow money supply growth to 16.9 percent in December from 19.2 percent in January 2006. Even so, urban real estate prices in China rose faster. Prices for apartments and offices in 70 cities increased 5.4 percent in December from a year earlier, after a 5.2 percent gain in November, according to the National Development and Reform Commission. Central bank Deputy Governor Wu Xiaoling said Jan. 25 in Davos, Switzerland, that China will tighten environmental controls to rein in overinvestment. Such measures ``would only slow growth marginally,'' says David Cohen, an economist at Action Economics in Singapore. ``Short of establishing currency controls like we've seen in Thailand, I don't think measures to reduce property prices across the region will have much of an impact,'' says Eugene Kim, chief investment officer of Tribridge Investment Partners Ltd. in Hong Kong, a hedge fund managing about $100 million. ``The wealth out there needs to go somewhere.'' ``There is too much money globally chasing meager returns, and the liquidity has found its way to asset markets,'' says Arjuna Mahendran, chief Asia strategist at Credit Suisse Group in Singapore. ``There is no perfect solution. If the flows aren't absorbed, you'll have a crisis at some stage.''
Reply to this comment By Dave Chiang on 2007-02-05 08:12:01
"Low observed volatility makes the real-denomianted carry trade even more attractive. And that pulls in even more money." That's why I referred to the phenomenon as a strange attractor when I worked up my follow-up commentary on your post yesterday. Dave Iverson Economic Dreams-Nightmares
Reply to this comment By Guest on 2007-02-05 09:04:54
See also the blogger "Macro Man" and his possibly-sour-grapes antithesis (he went short Yen/$ recently) which pulls together a good amount of data to assert Yen carry is really no big deal right now. Viz http://macro-man.blogspot.com/2007/02/nouriel-roubini-is-big-fat-idiot.html and ignore the title.
Reply to this comment By wcw on 2007-02-05 09:56:58
Brad, you were puzzled by why the Chinese currency might become a carry currency rather than a target. Some reasons for the Yuan being used by some in the carry trade are pointed out in Bloomberg editorial: http://bloomberg.com/apps/news?pid=20601039&refer=columnist_mukherjee&sid=aTyGjtMJxPM4
Reply to this comment By OldVet on 2007-02-05 12:41:00
I saw the mukherjee piece, and was still a bit confused ... it feels like a mix of an onshore/ offshore artibtrage (offshore RMB pay less than onshore -- so a good funding currency; onshore = 2% plus and the currency appreciation) and a bet that the RMB will appreciate by less than other asian currencies (destination currencies) with a bit more carry. OK, fair enough. but it also seems like the investment and commercial banks have a lot of demand for folks who want RMB simply for the appreciation (now that the pace seems a bit stronger), and are looking for someone else who wants to, in effect, sell RMB ...
Reply to this comment By bsetser on 2007-02-05 13:34:04
Anyone care to explain "Guest's" question about they steps 1 and 2 offer leverage. I agree with Guest that they seem to offset at T+2 and it is not clear to me how leverage is achieved through the first two steps. If anyone truly understands this, an explanation would really be appreciated.
Reply to this comment By Gamma on 2007-02-05 15:26:33
a couple of comments on macroman -- (the content, not the title ... ) 1) Re: Why isn't Japan's trade surplus bigger -- a) lags -- yen wasn't so weak not so long ago (04). watch 07 b) oil c) yen is only weak v. rest of the g-3. it isn't obviously weak v. the yuan d) don't forget about japan's exploding income surplus 2) positioning the macro funds that I know of tend to fund their long Nikkei positions with yen ... their hedging as the Nikkei rose was supposedly a source of pressure on the yen (i.e. higher yen = more unrealized profits in $ that needed to be protected v. slides in the yen). but that was an 05 story, not an 06 story what strikes me as different this time around is that I get a sense that -- as a result of diversification -- there are a lot more Japanese short yen positions (long kiwi, long us bonds, long european stocks, long you name it) than before. Mostly real money. but still mostly unhedged. If folks suddently started to hedge v. $ weakness or euro weakness v. the yen, that could potentially move the market. and, as for the limited on balance sheet cross border yen lending, i trust andrew rozanov. this is now done primarily thru swaps. finally, there is a lot of anecdotal evidence and market evidence (look at the swiss franc as well as the yen, and at destination currencies like the real) that lots of folks woke up on January 1 and answered the how will i earn my 2/20 in 07 question with the "put on a nice little carry trade" and then as the trade performed well, well, it got harder to sit on the sidelines/ take the other side. anyone out there short brazilian real local rates? outright short -- not hedging v CDS? My guess is no. it costs too much.
Reply to this comment By bsetser on 2007-02-05 15:29:29
"...Net six-month fund flows into the yen, the lowest-yielding currency of the 19 in its basket, are at their most negative since March 2000. They have only been more negative for 5 per cent of the time since State Street started tracking them in 1995. Similarly, net flows into the Swiss franc, the 17th lowest-yielding currency, have only been more negative for 4 per cent of the time since tracking began. By contrast, net fund flows into the Brazilian real, the highest yielding currency, have only been more positive 6 per cent of the time..." http://www.ft.com/cms/s/fd5df8a2-b544-11db-a5a5-0000779e2340.html
Reply to this comment By Guest on 2007-02-05 17:23:14
actually short real brazil bonds is strongly positive carry for a leveraged investor. ntn-b's yield 7.80 or so + sub 4% inflation funded at 13%. i think the long inflation linked trade in brazil is popular for its compelling fundamentals despite carry.
Reply to this comment By pb on 2007-02-06 10:32:37
pb -- i fear that I wasn't clear, i wasn't thinking "real" as in inflation indexed but "real" as in denominated in Brazilian real. and, judging from the price action and the brazilian reserve growth, there aren't many who are short brazilian real denominated assets. http://www.bloomberg.com/apps/news?pid=20601086&sid=aJIVQ4OEnyBo&refer=latin_america
Reply to this comment By bsetser on 2007-02-06 14:34:59
Brad, Either way, carry in brl debt (real ot nominal) is negative due to the inverted curve, with the nominal debt less so than inflation linked, and shorting is a positive carry trade when funded locally. If funded in usd, it is positive carry, but less so than just a simple currency trade. In other words, you decrease your carry while taking on more volatility/duration/credit risk, etc. I would agree that carry is the story in brl ndf and the currency futures on the BM&F, while the bonds are a different story (structural change in inflation, expected rate cuts, improving credit) in which leveraged investors are willing to pay away carry to go long.
Reply to this comment By pb on 2007-02-06 14:49:42
Guest, Gamma - Looks like I'm not doing a very good job of explaining what I mean... Sorry about that! Let me try and go about it from a slightly different angle. Imagine you are a bank dealer who has various corporate and institutional customers. Let's say Customer A (who could be a hedge fund, but not necessarily) comes to you and asks you to quote US$/JPY outright forward for 3 months. You offer him a quote. Based on that, he sells you JPY and buys US$ (say, US$ 100 mn) for settlement in 3 months. What does this mean? This means that you are now long JPY / short USD on a 3-month horizon. This essentially has 2 risks for you: spot rate risk and term structure risk (or, in other words, risk related to changes in the interest rate differential). Of these two, the spot rate risk is by far the largest and most volatile. So, unless you want to take an active proprietary position of being long JPY / short USD 100 mn on a 3-months horizon, you need to hedge this position. Thus, the first thing you do is you sell JPY / buy USD 100 mn in the spot market. Now you have only one problem remaining: duration mismatch. And there are two possible ways to solve this. Option 1 - Theoretical: actual borrowing and lending Having sold JPY and bought 100 mn USD in the spot market, you can borrow yen which you'll deliver and settle on T+2, while taking physical delivery of the US$ 100 mn. This gives you the dollars you'll need to deliver based on your outright forward obligation in 3 months' time. But for now you place these US$ 100 mn on deposit. In 3 months' time, you get the US$ + US$ interest, deliver against the yen, and repay the yen loan + JPY interest. While you could do this in theory, nobody ever does this in practice - too impractical, too much of a hassle, but most importantly - every act of borrowing and lending expands your bank's balance sheet, with obvious consequences for regulatory capital, etc. Instead, banks do the following: Option 2 - Practical: hedging in the spot + FX swap markets Go back to the point when you just ended up with the risk on your book of long JPY / short USD 100 mn on a 3-month horizon. Again, you hedge it first in the spot market - buy USD 100 mn vs JPY. Then, you do an FX swap transaction. Remember, an FX swap has two legs: buy currency A and sell currency B spot, and AT THE SAME TIME sell currency A and buy currency B for future delivery, say, 3 months forward. If you do this, the first leg of the swap CANCELS OUT the spot transaction you just did previously to hedge your spot risk (i.e. buy USD 100 mn and sell JPY, then sell USD 100 mn and buy JPY at the SAME spot rate), so no physical cash flows are triggered on T+2. All you are left with is a 3-month obligation from your original transaction with Customer A to deliver US$ 100 mn and receive yen AND your new obligation to receive US$ 100 mn and deliver yen in 3-months' time from the second leg of your FX swap hedge. You are now fully hedged! Notice how your transaction in the spot market and the first leg of your FX swap transaction CANCEL EACH OTHER OUT, leaving just an outright forward, which hedges your original obligation to customer A. It is EXACTLY the same concept as in my previous carry trade example of Spot Trade + FX Swap Trade, where step 1 and step 2 cancel each other out, leaving only step 3 - the outright forward. The only difference is that in my earlier example you're not doing it to hedge your risk, but to take risk in the most efficient and cheapest way possible. Hope this helps explain it a little better. Regards, Andrew
Reply to this comment By Andrew Rozanov on 2007-02-06 18:42:07
Thanks Andrew for explaining that again.
Reply to this comment By Gamma on 2007-02-07 14:11:53
Thanks Andrew. What confused me was why making an explicit FX step with outright forward (if you can get an outright forwad with favourable rate). The way you describe it (FX spot + FX swap) now is what I thought of when looking at the article originally.
Reply to this comment By enderv (was:Guest) on 2007-02-08 01:35:28
I have been discussing the yen carry trade in my work for some long time and I have enjoyed this discussion.The $1 trillion estimate comes originally from a piece of work I did, and I thought it only fair to contribute my explanation for anyone interested. In the work I accept that guesstimates for the size of the carry trade that can be derived from balance of payments and banking statistics fall in the range US$100-350 billion. However, as has been noted here, it is not necessarily the case that carry trades will show up in these statistics. Carry trade transactions could be on the other side, for instance, of hedging by Japanese exporters in the forward currency market, which would not show up in bank balance sheet statistics. The one trillion number is less a genuine 'estimate' than an indication of what I believe to be the order of magnitude. My guess is that the outstanding carry trade is probably even larger than this. There are a number of connected reasons for believing this, which I will try to summarise briefly; 1) The big adverse development in the Japanese balance of payments data (IMF data) that occurred subsequent to the massive intervention up to March 2004 was the deterioration in 'monetary capital' (i.e. increase in Japanese banks' net foreign assets). This suggests that it is carry trades that have weakened the yen, not Japanese institutional or retail funds going into foreign securities, and it suggests that the moral hazard created by the intervention was the original cause. 2) Indications of the carry trade such as Japanese banks' gross foreign assets, cumulative short-term net foreign lending from the Japanese bop, the spec net short position on the Chicago IMM correlate quite well with each other and also with the yen rate. I think these indicators do not tell us the size of the carry trade but they do tell us the direction. Again, these suggest that it is the carry trade that has been responsible for yen weakness. 3) Carry trade currency relationships are now enormously out of line with fair values. I have the yen about 30% undervalued against the dollar. The Turkish lira I have 130% overvalued against the yen, which is extraordinary. Turkish inflation is 10%, but the lira simply will not go down (bar the episode last spring). 4) The Japanese MOF/BOJ had to acquire roughly US$500 billion to prevent the yen appreciating up to March 2004. The yen is now much lower in real terms. Logically the amount of intervention next time round is going to have to be much greater - my estimate is roughly US$2 trillion. The idea that the carry trade is, say, only US$200 billion is inconsistent with this in my view. 5)There seems to be a relationship between the yen and the enormous credit bubble which now completely dominates global financial markets and the economy. In my work I had a chart (mainly for fun) showing the very close relationship between Goldman Sachs share price in dollars and the S&P 500 in terms of yen. There are plenty of other similar relationships I think you could show. When you add all this together, it is simply not plausible, in my view, that the carry trade could be as small as most observers are saying. The observed impact that the carry trade is having on the currency and other markets is too great. As to why hedge funds, investment banks and others have not been frightened out of it, I think they have 'learned' that it 'always works' in the end, much as technology growth stock investors 'learned' in the second half of the 1990s. They do not see how it could possibly go badly wrong until Japanese rates have been raised significantly, and they see no prospect of that. Tim Lee
Reply to this comment By Tim Lee on 2007-02-08 10:42:17
Can one actually capture the spread yen/dollar: ~5% leverage 2.7x = 13.5%/yr and have your original principle 100% safe?
Reply to this comment By Guest on 2007-06-08 17:36:56

Only 3% of US consumption came from higher Home Equity!

2009-02-18T11:19:00.000-08:00

There is a general misconception that the housing boom was the main source of US consumption. That boom seems to have ended decisively. Therefore, ordinary investors frequently wonder how the US economy will recover.
In an essay from Paul Swartz at Brad Setser's blog the US mortgage credit levels are examined in relation to the housing boom.
This paper by Alan Greenspan and James Kennedy is referenced in Paul Swartz’s essay.
Here’s my analysis of the percentage of US consumption that came from cashing out on US home equity:
Only 3 percent of spending (2001-2005) came from using homes as ATMs!!!
An excerpt from the Greenspan/Kennedy paper linked above:
” According to our estimates, from 1991 to 2005, equity extracted from homes was used directly to finance an average of close to $66 billion per year of PCE, about 1 percent of the total (lines 9 and 10). From 1991 to 2000, equity extraction financed an average of 0.6 percent of total PCE, but since then that share has risen to almost 1-3/4 percent. If we include non-mortgage debt repayments (in which, as mentioned above, installment debt is used as bridge financing for PCE, with home mortgage debt as the ultimate source of funding), equity extraction financed an annual average of about $115 billion of PCE from 1991 to 2005, 1.7 percent of total PCE (lines 12 and 13). By this broader measure of PCE funding, equity extraction financed 1.1 percent of PCE from 1991 to 2000 and close to 3 percent from 2001 to 2005.”
In my simpler words:People got money out of the mortgage boom by selling homes, taking out new home equity loans and taking cash out refinancing loans. They repaid some non mortgage debt and spent other money directly on personal consumption expenditure. The total of that non mortgage debt repayment and the PCE is only 3% of the total PCE in the US economy for the years 2001-2005!
Since 2005 is the last year of data in the paper linked above, I've separately calculated the percentage for that year below: (Please refer to Table 2 in the paper) For 2005, line (1) in Table 2 shows a total home equity free cash extraction of $ 1,428.9 billion. $ 143.9 billion of that was used to repay non mortgage debt (line 5), and $ 182.7 billion was used for PCE (line 9).According to NIPA total PCE in 2005 was $8893.7 billion. $326.6 billion, or just 3.67% of PCE was financed by using homes as ATMS in 2005.Suppose from the NIPA table you exclude “durable goods” PCE altogether. Of the total non-durable goods PCE, only 4.14% came from using homes as ATMs. If using homes as ATMs only funded a small percentage of the PCE in US GDP, there’s a great deal of hope for US economic recovery once the ongoing credit squeeze is sorted out with the Geithner bank bailout plan.

THE U.S. Housing Market

2009-02-18T03:55:00.000-08:00

As of 2007, there was one housing unit available for every 2.35 persons in the United States. As of 2007, around 5.61% (7.19 million out of 128.20 million) of housing units were newly constructed within the previous 4 years. Around 10.22 % of housing units (13.11 million out of 128.20 million) in 2007 were technically ‘vacant’ (they were either just vacant, or were meant for occasional use).This data shows that in 2007 an equilibrium between the number of available housing units of good quality, the U.S. population, and the average size of an American household was approaching. Even as housing starts were proceeding at a hectic pace, occupation demand for new units peaked out, with more than 10% of existing units being technically vacant.Increasing inventories, decreasing starts, flattening home prices, and unwinding of highly leveraged housing investments marked the market adjustment to this new equilibrium.In 2008, the correction over extended itself, leading to a general implosion of credit in unrelated sectors. A housing recovery is on since December 2008 with falling inventories, and increasing sales volumes. My guess is that home prices will just stabilize somewhere, and mortgage credit will gorw very slowly, allowing further re distribution of home ownership over time rather than a further rapid expansion of the supply of homes in the U.S.
Data Summary:As of 2007, there were 128.20 million housing units in the United States. Of these , 13.11 million units were vacant. Owners occupied 75.65 million and renters occupied 35.05 million units. Of the 13+ million units considered vacant, 2.94 million units were for occasional use. So it seems that holiday homes, etc are included in that 13+ million as ‘vacant’. As of 2007, out of the total 128.20 million units, 7.19 million units were newly constructed within the previous 4 years. Around 8.71 million of these units were mobile/manufactured homes.As of July 01, 2007 the population of the United States is estimated to be 301.29 million and as of July 01, 2008 the population estimate is 304.06 million.Dividing the 301.29 million population by the 128.20 million housing units, you can conclude that there was one home for every 2.35 persons in the United States as of 2007.
Data sources:Housing units data:American Housing Survey:2007(U.S. Census Bureau)http://www.census.gov/prod/2008pubs/h150-07.pdf(Go to page 16 in the PDF file, enlarge to something like 200% and have a look at the bold line in Table 1A-1: Introductory Characteristics - All Housing Units)
Population Estimates data:
U.S. Census Bureau, Population Estimates Program, American Factfinder:
http://factfinder.census.gov/servlet/DTTable?_bm=y&-geo_id=01000US&-ds_name=PEP_2008_EST&-_lang=en&-mt_name=PEP_2008_EST_G2008_T001&-format=&-CONTEXT=dt
(The population estimates are in the table at this page above)

Balance Sheet of The Federal Reserve Bank

2009-02-17T01:00:00.000-08:00

Here's a link to the latest Federal Reserve Bank Balance Sheet.
The 'US Treasury, supplementary financing account' has a balance of $199,950 million as of 11 FEB 2009. This item is the balance in one of the Treasury's accounts with the Fed. The Treasury supplementary financing account was created in response to the 2008 credit crisis. That's why you see that the change in the account since 13 Feb 2008 is the same as the current balance in the account.
The US Treasury supplementary financing account is a part of factors absorbing reserve funds, other than reserve balances. What this means is that the Fed, in its role as the banker to the US Treasury, has given a credit of $199 mn to the US Treasury in an account, and the Fed has a liability to pay this amount to the Treasury.
Normally, when the US Treasury issues debt securities, it should receive the cash, and instead, here it's received a liability from the Fed. The balance in the 'Treasury cash holdings' account is $ 273 million as of 11 Feb 2009. Since 13 Feb 2008, the Treasury's cash balance at the Fed decreased marginally by $ 2 million.
This is an example of how the Fed's balance sheet expanded to provide credit to banks in response to the 2008 credit crisis. Basically, the Fed borrowed from the US Treasury and then extended credit to the banks in turn. The Treasury borrowed from the market, including foreign central banks, during 2008.
Have a look at the various items in 'total factors supplying reserve funds', which represents the Fed's assets. You get a series of items there, such as credit extended to AIG, purchases of Agencies, Mortgage Backed Securities, and so on. The money borrowed from the market in the name of the US Treasury was then lent to the Fed; the Fed then purchased MBS, and so on; in turn the Fed extended credit to the banks. The US Treasury now owes money back to the subscribers of bills and bonds; and that has to be paid mostly out of the general revenues of the Congress.
Through this route, banks have exchanged bad debts with the Fed, in return for fresh credit from the Fed, so they're no longer liable for those losses. The Fed is relying on the Treasury to payout as its bills mature. The Treasury is relying on its fiscal resources to pay those bills. The Fed will experience the losses from bad debts on its books in due course. And American taxpayers lent ~ $ 2 trillion in 2008 to banks, with no discussion on the issue in Congress. In spirit, this is a diversion of Congressional appropriations to the Federal Reserve, which is a transgression of the intentions of the Federal Reserve Act. The legal technicality probably is that the Treasury supplementary financing account can be taken as a deposit made by the US Treasury at the Fed, which in letter perhaps makes the Fed's action legal.

The US Trade Balance with China

2009-02-10T08:10:00.001-08:00

The US Trade Balance with China (2001-2008) totals to $1.41 trillion.
From the US Govt. census web site I totaled the trade balance with China for the last 8 years:
Year $ million
2001 $83,096.10
2002 $103,064.90
2003 $124,068.20
2004 $161,938.00
2005 $201,544.80
2006 $232,588.60
2007 $256,206.70
2008 $246,453.10
TOTAL ------------- $1,408,960.40
Reference: http://www.census.gov/foreign-trade/balance/c5700.html
The total US Trade Balance 1992- 2007 is $ 5.39 trillion.
Year $ Million
1992 -$39,212.00
1993 -$70,311.00
1994 -$98,493.00
1995 -$96,384.00
1996 -$104,065.00
1997 -$108,273.00
1998 -$166,140.00
1999 -$265,090.00
2000 -$379,835.00
2001 -$365,126.00
2002 -$423,725.00
2003 -$496,915.00
2004 -$607,730.00
2005 -$711,567.00
2006 -$753,283.00
2007 -$700,258.00
TOTAL -$5,386,407.00
Reference: http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm

Total United States Public Debt outstanding:

$ 10,717,280,371,345.89

Reference: http://www.publicdebt.treas.gov/

China has an estimated $ 1.45 trillion of USD denominated foreign exchange reserves, consisting of US Treasury and Agency debt.
(from Brad Setser's estimates and links below)

"Consequently it should be a surprise that China’s government now has close to a trillion in Treasuries. OK, not quite a trillion. But darn close. $860 billion or so at the end of November and – if current trends continue — over $900 billion at the end of December. China also has $550 billion or so of Agencies, which are effectively now backstopped by the Treasury. That works out to an enormous bet by China’s government on US government bonds. "
- Dr. Brad Setser
Reference:
http://blogs.cfr.org/setser/2009/01/30/secrets-of-safe-a-trillion-or-close-of-treasuries-here-a-trillion-there-and-pretty-soon-you-are-talking-about-real-money/

http://www.cfr.org/content/publications/attachments/CGS_WorkingPaper_6_China.pdf

http://www.bea.gov/newsreleases/international/trade/2009/pdf/trad1108.pdf

A few notes on the US Govt. finances and the value of the US Dollar

2009-02-10T02:50:00.000-08:00

Fortunately my views on the US Govt. finances aren’t controversial at all and I’m just repeating what something called the accountability office has been repeatedly warning for quite some time.USG has a total debt of $10 trillion plus and the lowest estimate of this year’s deficit is “more than $1 trillion”, from Brad Setser. Other commentators are guessing anywhere from $2 trillion to $ 3 trillion.If the US Govt. is paying interest on its $10 trillion debt, that interest is being paid out of more borrowings, rather than from its own surplus.The US latest annual trade deficit with China is close to $20 billion. Even if you assume trade deficits with China have been at the same level for the last 8 years, you’re only accounting for a max of $ 160 b in USG Govt. debt, with an assumption that each dollar of China trade deficit leads to a dollar of USG debt.Where’s $160 billion over EIGHT years and where’s a TOTAL USG debt of more than $ 10,000 billion?In this analysis we’re ignoring the estimates that very soon trillions in medicare and social security are going to fall due in the next few years, so the USG deficits are likely to widen further rather than soften.Despite these terrible looking numbers I don’t expect the USG to default in the immediate future. To paraphrase Dr. Roubini, let me now explain in detail why.

Sorry small correction: China has a trade surplus of around $200 billion and around 40% of its exports are to the US. So the latest US trade deficit with China is likely closer to $ 80 billion, and not $ 20 billion as I mentioned above. The trade deficit with China accounts for something like 45% of the overall US trade deficit.Even with this correction, it’s easy to see that the level of total USG debt can’t be explained by China imports, or imports overall, over the last 8 years.

Why at least 2014?As of now the US dollar has a “unique role in international trade” and thereby offers “an exorbitant previlege” to the US Govt. to run “painless deficits”. (These are official terminologies so there’s nothing controversial in using them.)The dollar’s unique role is that most of the international trade amongst third-party nations is settled in USD. Of this, the most compelling is the trade in crude oil, a commodity that most countries import.Till recently around 63% of foreign central bank reserves were held in USD. Combined these together, and you get a realistic explanation for why the USD is overvalued more than 1000% in most exchange rates.This situation never came about as a result of “mercantilism”.This is more a result of US foreign policy objectives since the 1970s, starting with Middle-East military agreements, and the exercise of other geopolitical influence to make sure that the surplus of oil-exporting nations can be accumulated in USD and recycled.The USG will stop receiving foreign funding only when foreign central banks shift away from the USD for their reserves. That requires a shift away from trade settlement in USD. This process requires a widespread perception and understanding that the US geopolitical influence is at an end. That influence is derived from the US military.Unless the US military loses its ability to dominate the world, there will be no complete drain on foreign funding for the USG.Secure in this knowledge, advantages can be gained by asking China to strengthen its RMB, so that the Chinese economy can suffer a further pandemonium, and just as in the case of Argentina in 2001-2002, larger chunks of the local equity market can be purchased by foreign investors at 10 cents on the dollar.

Since 2008: German foreign minister Steinbruck said in media interviews that he prefers a combination of USD, EUR, JPY and RMB as forex reserves rather than predominantly USD. GBP was conspicuously absent in his list. At Davos, Russia’ Putin warned against excessive reliance on one reserve currency. Iran’s Ahmedinijad made self congratulatory speeches in which he claimed that his decision to replace the USD with EUR in Iran’s reserves was both politically and economically advantageous. Even French President Sarkozy expressed misgivings about the USD prior to the 1st G-20 crisis summit.The update is that Russia seems to be rapidly exchanging USD from its reserves for trade & political advantages, a move that Dr. Roubini predicted in his writing with the topic something like “Decline of the American Empire” in late 2008 which is there on his web site.Last week, Russia made out a $350 million loan to Cuba in exchange for information and drilling rights in the Cuban part of the Gulf of Mexico. At a summit of the newly rejuventated CSTO (Collective Security Treaty Organization), Dmitry Medvedev offered a full $2.15 billion to Krygystan, $ 2 billion in loans and the rest in aid.Now I have given you the direction in which you need to reason to know when the USG may at all be forced to default. You have to know the geopolitics from Darfur to Afghanistan, and it’s no joke. My guess is that it will take at least a few more years for the ROW to come to any drastic conclusions about the “value of the US dollar”.

TAPI Petroleum Gas Pipeline

2009-01-22T08:49:00.000-08:00

The Turkmenistan Afghanistan Pakistan India Petroleum Gas pipeline is scheduled for the start of construction in 2010 and the projections are that it will provide its first supply to India by 2015. The pipeline will run 1040 mi (1,680 km) pipeline will run from the Dauletabad Gas field in Turkmenistan to the Indian town of Fazilka, running through southern Afghanistan (Herat-Kandahar);and Quetta and Multan in Pakistan. As of 2006, Dauletabad had around 1.4 trillion cubic meters of gas reserves left. The pipeline has ane stimated cost of $ 7.6 million and the Asian Development Bank is co-ordinating efforts of the steering committee of the four nations' petroleum ministers. ADB is providing technical assistance in the form of feasibility studies, etc and it's agreed to provide financing for the project subject to the condition that it wouldn't crowd out private investors.
The project according to ADB studies is economically and financially feasible. The pipeline has a designed capacity of 3.2 billion cubic feet per day (around 30 billion cubic meters per year)

"Failure to Deliver" in the US Treasury market

2009-01-17T07:17:00.000-08:00

At this post on credulous_prole's utterly correlated blog page Dr. Susanne Trimbath's work on the mechanics of the "failure to deliver" in the US Treasury debt market is explained.
Dr. Brad Setser's analysis of the latest Treasury International Capital (TIC) data for November 2008 shows a marked shift from long term to short term Treasury debt purchases by foreign central banks. His previous analysis shows a large volume of private purchase of US Treasuries in 2008.

Here's an extract from Dr. Susanne Trimbath's article:
"Because the financial regulators do not require that the actual bonds be delivered to the buyer, your broker credits you with an electronic IOU for them, and, eventually, with the interest payments as well. But the so-called “bonds” that you receive as an electronic IOU, called an “entitlement”, are phantoms: there aren’t any bonds delivered by your broker to you, or by the government to your broker, or by anyone. "

I strongly advise the reader to go through her entire analysis.

I think Dr. Trimbath's analysis might have a connection with the reduction in long term Treasury purchases by foreign central banks. I could be wrong here.

Theme: The Geoeconomic World War

2009-01-16T23:45:00.000-08:00

The purpose of this essay is to elaborate on the theme of this blog. Private investors in India are concerned with the performance of stock market indices and the profitability of investments in particular sectors of the Indian economy. These barometers are affected significantly by geo economic and geo political developments which exercise what is largely an influence that is in my opinion under-appreciated by domestic investors.
A full fledged geoeconomic war is raging, a war in which few sovereigns and regions have the choice of an insulated neutrality, in my opinion. My view is that the decisions and actions of most policy making organizations constitute an effort to strike a balance amongst various interests, rather than a tendency to focus on a more general nationalism that is symbolized by these entities.
The oil and gas industry is one of the focus areas of this blog. The process of exploration, extraction and distribution of petroleum and petroleum gas products involves several significant policy interactions. Given the scale and economic importance of these activities, these interactions constitute what should be understood essentially as being amongst large rival commercial organizations operating in this sector. Oil companies however, can exercise a competitive influence on policies of a particular sovereign versus those of another; and influence that also acts in different directions on the policies of a particular sovereign.
Competition in this sector appears to have recently intensified to the respective financial sector backers. Those institutions exercise influence on the availability of credit; and therefore on the monetary policies of independent central banks; and the fiscal policies of sovereigns. Study of the ownership (and significant rapid changes in ownership); of financial institutions in different geographies is therefore reflective of geopolitical influences at cross purposes.
The competitive dynamics in the oil and gas industry has also broken out in more visible political events: such as regime changes, and, more recently, medium intensity military conflicts involving sovereigns and militant groups.
The overarching objective of analyzing information along these dimensions is to predict the likelihood of resolution of these conflicts. While there is a natural tendency to favor the limitation of collateral damage; for instance, in the form of widespread unemployment, or vicitimization of unarmed civilians in armed violence; that predisposition does not entail any political, nationalist, religious or other ideological affiliation for this author.
It follows that the resolution of these conflicts augurs very well for the performance of the stock market barometers, though limiting the collateral damage has much more humanitarian significance than the improvement of the stock market barometers.
It is also true that we should expect the markets to look ahead towards a particular resolution rather than wait on it to actually occur, and I hope this blog will contribute to the market participants' efforts to look ahead.

Another Volte Face on Extradition of Mumbai Terrorists

2009-01-16T22:37:00.000-08:00

Pranab Mukherjee: " We have never given up the demand that the perpetrators of terror acts should be extradited to India. There is no question of that or climb down."
The deal is more obvious now, according to me. If Pakistan wants to be friends with Iran, it can't be friends with India at the same time. Because Indians are great pals of the US Department of State. And the Department of State is friends with Israel. Israel doesn't like the Hezbollah and the Hamas. Iran happens to be supporting the Hamas quite openly.
This is like a geo-political roulette wheel :-)

Nuclear Power: Westinghouse Electric Company

2009-01-16T22:27:00.000-08:00

Westinghouse Electric Company, a US-based nuclear power firm, signed a memorandum of understanding with India's largest engineering company, Larsen and Toubro Ltd. to manufacture modular nuclear power reactors yesterday (Friday).
WEC is also exploring the possiblilty of a partnership with the state owned Nuclear Power Corporation of India, Meena Mutyala, WEC's vice-president for global growth and innovation, said. (Source: Print editition of The Economic Times today)
Other corporate nuclear power companies with plans to set up in India include General Electric and Areva, a France-based company with a listed unit in India.
The Russian government representatives also visited New delhi and signed a vague MoU related to nuclear power. I don't rate the chances of a Russian firm manufacturing nuclear power reactors in India as very high, for obvious geo-political reasons.

Geopolitical Insights from "The Economic Times" (today's print edition)!

2009-01-16T06:46:00.000-08:00

The following analysis is from the January 16, 2009 print edition of The Economic Times (Bennett,Coleman & Co Ltd.).

On Page 02 you see the report titled "Pranab will settle for Pak trial now". Foreign Minister Pranab Mukherjee is now willing to accept a transparent trial in Pakistan for those who have committed crimes against India, viz. the perpetrators of the Mumbai terror attacks. What Pranab Mukherjee actually said, and he is quoted in the paper is: "Indian fugitives should face Indian justice. Others who have committed crimes against India should also be extradited. But if for some reason that is not possible, then there should be a transparent trial in Pakistan." The author correctly sees this as very different from the earlier Government of India demand that the terrorists should be "handed over to us to face trial".

On Page 19, there is a small block titled "Pakistan might opt out of IPI gas pipeline project". 'An unnamed Petroleum Ministry official' (in Islamabad) has told the Economic Times journalist that with Iran seeking an exorbitant $10 to $11 per mmBtu of gas from Pakistan, Pakistani authorities might recommend to their Parliament to abandon the proposed $7.4 billion tripartite Iran-Pakistan-India gas pipeline project.

India has been uninterested in having any agreement with Iran over this proposed project for quite some time now. Remember that the earlier Petroleum Minister of India, Mani Shankar Aiyar stepped down from his portfolio and Murli Deora became the new Petroleum Minister precisely because the Government of India was not interested in having either a petroleum pipeline, or a petroleum gas pipeline built from Iran through Pakistan to India. Mr. Mani Shankar Aiyar was a career diplomat in the Indian Foreign Service who was posted in the Middle East for a long time.He later won election to the Parliament and was an aggressive proponent of the Iran-Pakistan-India oil pipeline project. The United States plan is to have a new pipeline built southwards from the Caspian Sea through Afghanistan to an Arabian Sea port in Pakistan.

The report today that Pakistan hasn't yet finalized their decision on the project, but that they now might not go for it, is therefore representative of some kind of a shift on this issue.

The two reports are obviously linked. The United States Department of State, behind the scenes, is brokering a deal here. The deal is simple. Pakistan shouldn't co-operate with Iran. They should go for the US-backed pipeline project instead. Then the Department of State friends in India won't go after the Zardari regime to extradite their henchmen, who conducted the Mumbai terror attacks.

This post should also indicate to you good methods to use while reading the financial press. It's important to separate facts from interpretations made by the authors. It's even more important to acquire a contextual awareness, either by reading over time, or by reading related materials when you come across something new. You're advised to cultivate the ability to link various reported developments (that you consider as facts) and understand the evolution of the unfolding themes. It's a very good habit to check data from different sources to be sure that what you think are facts are supported by various commentators.

Infosys "Constant Currency" Q3 results!

2009-01-16T05:55:00.000-08:00

I don't have anything against Infosys. This is an objective assessment of what was stated by the Infosys Board members on CNBC TV18 telecasted discussion of the Q3 results.

Along with millions of investors, IT employees, etc I watched the Infosys Q3 results discussion with the highly regarded Infosys Board; with presenters Udayan and Mitali a few days back. My view is that Infosys revenues fell during Q3. Infosys fired a large number of people and asked a large number of people on site to go on loss of pay leave. This reduced their outflow on salaries. The USD/INR exchange rate improved the company's margins. Overall, revenues fell in all geographies when measured in the same currency against previous quarter numbers. Margins improved because of a stronger dollar, and because of the culling of the bench. Infosys didn't do anything miraculous in terms of their business process to improve their margins dramatically.

The outlook for CY 2009 is truly dire. A lot of clients are on the verge of bankruptcy filing. There's little chance of any new projects coming Infosys's way. It's a volatile currency world. Infosys just has an unsophisticated foreign currency receivable hedging process, in which they mainly use non deliverable currency forward contracts, like a commodity export/import business. There was really nothing objective to cheer about in the Q3 results. Yet the stock price rose after the Board's TV discussion of the Q3 results.

At the Q3 results discussion the "constant currency" reasoning was presented by the Board.

While discussing revenues, the Board asked investors to take the view that there wasn't much decline in "underlying business volume" because you have to allow for the currency fluctuation. For instance revenues from the UK and Europe showed up lower when measured in USD because the US dollar strengthened against the GBP and EUR.

While discussing margins and net profits, one Board member stated that Infosys has a model which helps them to retain high margins even when the utilization is lower. The current crisis is a test of the model, he indicated.

I don't think there is any such model which can defy basic arithmetic. The viewer was supposed to accept the revenue as ok, as not having declined much, in "constant currency" terms. While looking at margins and net profit, the Infosys Board didn't apply their constant currency argument.

The good margins weren't because of a strengthening dollar, according to the Infosys Board. Infosys has a secret model that nobody has heard of. The model helps them to make high margins even when they have fewer people working on projects.:-)

Sold Satyam @ Rs. 36.45 on Jan 12

2009-01-16T05:43:00.000-08:00

I didn't make any posts since Jan 12. On Jan 12, in the afternoon after lunch I noticed that Satyam had gone up to around Rs. 36.50. I sold it on instinct. I had previously exited my Nifty shorts as I mentioned somehwere else. Since the 12th I haven't done any trades.
I was bearish on the Nifty for the January series. I exited all my shorts the day of the Satyam Panic and after that I went long in Satyam delivery, stayed on for one trading day with a weekend in between and sold off the Satyam shares.
I've had a lot of difficulty taking a view on the Nifty since the day of the Satyam Panic.

No view on Nifty this morning

2009-01-11T19:32:00.000-08:00

I closed out my Nifty shorts in the wake of the Satyam panic and bought Satyam at Rs. 21.05. Today I have no view to offer on the Nifty.
It's the third anniversary of my late father's passing away today.

January 08 2009 - EGoM decision on RIL Gas supplies to Reliance Power

2009-01-10T01:23:00.000-08:00

Anil Ambani's entity plans a Gas based power plant at Dadri in uttar Pradesh and the EGoM has decided to direct RIL to supply gas to the 7,480 mw plant if it's available from the Kaveri-Godavari basin. The EGoM meeting was attended by Petroleum Minister Murli Deora, Law Minister HR Bharadwaj and Power Minister Sushilkumar Shinde, according to a front page ET exclusive report in the financial daily, The Economic Times dated January 08, 2009. The article is titled 'End in sight to Ambani Gas Row'.

December 24 2008 - Justice KK Tated Transferred to Aurangabad Bench from the Mumbai High Court

2009-01-09T23:04:00.001-08:00

Justice KK Tated was transferred on December 24 2008 as part of a routine re shuffle. Ram Jethmalani and Mukul Rohtagi, both lawyers representing RNRL requested continuation of Justice KK Tated on the same Mumbai High Court Division Bench to facilitate early hearing of the case.

December 11 2008 - Govt Withdrew its affidavit filed in favor of Mr Mukesh Ambani

2009-01-09T22:58:00.000-08:00

http://domain-b.com/industry/oil_gas/20081211_government_withdraws_affidavit.html

The Division Bench of the Mumbai High Court consisting of Justice KK Tated and Justice JN Patel suggested the Government withdraw its affidavit stating that "Sale of Gas at a price less than $4.20 per million British Thermal Units is not envisaged according to the decision taken by the Government of India's Empowered Group of Ministers with respect to the Production Sharing Contract between the Govt. and Reliance Industries Ltd.", according to the linked article.

The RIL-RNRL dispute

2009-01-09T22:53:00.000-08:00

This article provides good numerical facts about the dispute but appears to me to be slightly biased.

The CPI Central Committee condemns the Essential Services Management Actions

2009-01-09T22:44:00.000-08:00

Here today you see that The Central Committee of the Communist Party of India has condemned alleged arrest and detainment of the officers of the 14 Oil Public Sector Units under the Essential Services Management Act and the Government's threat to 'call in the Army' to deal with the strike.
"The major point of demand has been the demand of the officers for a "five year tenure" of their wage-revision instead of ten years." according to this article.

Executives of Indian Oil Corporation and Gas Authority of India Ltd. strike for 3 days and end it today

2009-01-09T22:34:00.001-08:00

Another IBN Live report states the strike has ended with hard talk on wages from Petroleum Minister Murli Deora.

Russia's Gas Supplies to Europe through Ukraine

2009-01-09T22:06:00.000-08:00

Daryna Krasnolutska in Kiev reported on Bloomberg that at 07:44 a.m. on January 07, 2009, OAO Gazprom, Russia's Gas export monopoly cut off ALL GAS SUPPLIES TO EUROPE THROUGH UKRAINE. This was confirmed both by NAK Naftogaz Ukrainy, the Ukranian utility and by Alexander Medvedev, the Deputy Chief Executive Officer of OAO Gazprom.
The article quotes the Naftogaz spokesperson, Valentin Zemlyanski as saying that Gas supplies to EUROPE through Ukraine were CUT to 74 million cubic meters a day from the normal levels of about 300 million cubic meters a day.
The reason for the capitals is to make sure the article is understood correctly. Russia significantly disrupted European Gas supplies on January 07. Read the post below to know what happened to Iran's Gas supplies in the following week.
I don't have sufficient insight right now on OAO Gazprom's Nord Stream and South Stream Links for Gas exports to Europe. I'd appreciate any further information/insights.

Reliance Industries Ltd., The US Exim Bank and Iran Gas supplies

2009-01-09T21:49:00.000-08:00

On Dec 20, 2008, this report on India Business News Live stated that 8 United States Congressmen, 4 from the Republican Party and 4 from the Democratic Party wrote to James Lambright, President of the United States Export-Import Bank asking the bank to secure an understanding with Reliance Industries Ltd. that gasoline supplies to Iran will be suspended before the disbursement of two loan guarantee packages worth $ 900 million. Prior to the Exim bank transaction, RIL received a loan of $ 400 million from JP Morgan in August 2008.
The Reliance Industries Ltd. expansion program will significantly improve United States exports to India.
On January 08, 2009, energy business review reported that RIL has announced it is suspending gasoline supply to Iran after fulfillment of its existing contract.
Following an Iran News Blog with great cartoons on it has paid off in terms of financial insight today.

Buy Satyam at prices between Rs. 20 and Rs. 25 today for a long term profit

2009-01-09T00:39:00.000-08:00

Starting with my disclosure, I just turned bullish on Satyam at Rs. 21.05. My volumes are insignificant and I want to hide my trade data to create a deliberate miscalculation in the reader's mind that I might secretly be a billionaire.
Today I'm betting that Satyam will continue as a going concern.I'm also assuming that Ram Mynampati and various other folks in the Satyam management will continue to be on the Company's rolls. I would put margins in the Indian IT services industry at close to around 28% operating margin when INR/USD is at around 42. Satyam's market cap today is close to Rs. 707 crore. Last year's annual revenue was well above Rs. 8000 crore. If the company continues, then my money will come back at most in a year's time, by the most conservative possible estimate.
Satyam has frequently delivered quarterly net profits worth hundreds of crores. It's stock price is down from around Rs. 170 levels during the recent controversy, and much higher levels before the Maytas campaign began in earnest. Satyam is a good buy.

Gulf of Mannar Oil Exploration and The Fall of KiliNochchi

2009-01-08T02:56:00.000-08:00

On closer scrutiny the theme of the conflict in Sri Lanka is the same as that on the Gaza strip. The Air Tiger attacks on oil storage facilities, especially in the Sinhala capital of Colombo have prejudiced powerful international interests to ensure the decimation of Tiger forces in Lanka.
The Gulf of Mannar is being explored by the Government of India owned Oil and Natural Gas Corporation Videsh Ltd., British owned Cairn Energy Plc. (through Cairn India and Cairn Lanka), and the China National Petroleum Corporation.
I'm posting several links on the Gulf of Mannar Oil exploration for reference.
http://www.google.co.in/search?hl=en&q=Tigers+attack+oil+storage+facilities+from+the+air&meta=
http://karainet.blogspot.com/2008/03/offshore-oil-and-production-sharing.html
http://www.ongcindia.com/financial_30Sept_08.asp
http://www.pucsl.gov.lk/pdf/ENERGY%20POLICY.pdf
http://www.kompass.com/en/LK005838#
http://www.ustr.gov/assets/Document_Library/Reports_Publications/2007/2007_NTE_Report/asset_upload_file713_10981.pdf
http://www.laugfs.lk/profile/laugfs_profile.pdf
http://www.southasiaanalysis.org/\papers22\paper2181.html
http://www.livemint.com/2008/02/01142540/ONGC-Cairns-India-bid-for-Sri.html
http://www.thesundayleader.lk/20081005/BUSINESS.HTM
http://www.tamilnet.com/art.html?catid=13&artid=23425
http://lankasun.com:8000/index.php?option=com_content&task=view&id=7104&Itemid=28
http://www.rediff.com/news/2009/jan/02ltte-concedes-kilinochi-defeat-in-lanka.htm

Update: Who owns Satyam Today?

2009-01-07T20:31:00.000-08:00

CNBC TV18 reported at the end of trading yesterday that Aberdeen Asset Management, the largest shareholders of Satyam till yesterday, sold all of their 5.3% holdings in the company at close to Rs. 40 levels. Similarly the volume of trade in Satyam shares was nearly 50% of the total shares outstanding.
This should raise a significant question in the investor's mind as to who owns Satyam as of this morning?
I would like to reverse my recommendation to readers to go long on Maytas. Not just yet.
Today I'm going back to my analysis of the Natural Gas industry.

Thanking Dr. Brad Setser

2009-01-07T08:15:00.000-08:00

Estimating the Currency Composition of India's Forex Reserves:
The composition of india’s reserves can be inferred, in very broad terms, from the scale of the valuation gains that india reports on a quarterly basis in a document put out by the RBI called something like sources of accretion to the foreign exchange reserves. the split between currencies in the SDR basket and other currencies is also disclosed as part of the data india discloses on its reserves through the imf (see the reserves data on india’s imf country page)

FIIs and the Satyam Board: Executive Summary

2009-01-07T07:53:00.001-08:00

Satyam's plan to acquire Maytas, an Infrastrucuture firm run by the Satyam promoter family, created a widely reported controversy over Satyam's Corporate Governance. The promoter family owned very little stake in Satyam while FIIs were the largest shareholders. FIIs alleged overvaluation of Maytas equity in the deal, and pointed out the strategic irrelevance of the IT services firm's diversification into Infrastructure. Independent Directors on the Satyam Board were attacked by FIIs, the financial media and one Member of Parliament for their complicity in approving the controversial deal, and all except one of the independent Directors resigned.
FIIs demanded the resignation of Satyam's promoters and approached several strategic investors such as IBM,Oracle, HCL and Tech Mahindra to buy out the promoter stake in Satyam. Strategic investors demanded a lower valuation of Satyam's equity despite the stock having plummeted due to the Maytas deal controversy.
This morning Mr.Ramalinga Raju, Satyam's promoter, resigned from the Satyam Board. In his resignation letter Mr. Raju revealed a total overstatement of Rs. 7,000 crore (around $1.45 billion) on Satyam's books as of the September 30, 2008 Balance Sheet. Mr. Raju, the outgoing Chairman of the Board, claimed individual personal responsibility for manipulating the Company's accounts;overstating revenues and assets; and understating liabilities; over a period of several years without the knowledge of any other Board members or the Managing Director.
It appears that what has really happened is that Mr. Raju has diverted the money from the Company during the recent controversy. This action was probably motivated by the FIIs' unwillingness to allow him to continue to run a Company which he personally founded and built from a few people to a headcount of more than 50,000 over a period of 20 years.
It is unlikely that the money will be traced through investigations. This correct understanding of the Satyam issue indicates that a significant part of the Rs. 7,000 crores diverted from Satyam will find its way to the Maytas stock behind the scenes. I would therefore advise investors with a 2 year horizon to go long on Maytas.

Satyameva Jayatey Part II: The True Story about FIIs and the Satyam Board

2009-01-07T06:17:00.000-08:00

This is a slightly long explanation of the Satyam controversy but interested private investors and policy makers will benefit a great deal from knowing the true Satyam story.
If you have been following the developments surrounding the 2008 credit crisis then you are probably aware that the current global macroeconomic environment is one of low levels of aggregate demand and deflationary pressures in the major world economies. Foreign Institutional Investors in the Indian stock market are free to invest in equities and other instruments across various geographies and sectors. If you had a choice of long term equity buys, which sector would you choose? According to me, the emerging markets infrastrcuture sector, specifically sectors such as the Electric Power Sector in India, offers an attractive opportunity to global investors due to the current macroeconomic environment.
While most sectors in various global economies are facing demand shortages, the Indian infrastrucuture sector continues to be in a situation of high levels of demand and low levels of supply. If you are an urban consumer of electricity, for instance, you would not appreciate disruption of power supply for an hour or two in a day. Urban consumers are perfectly willing to pay the additional electricity bill, and and saving from this amount makes little difference to the overall household budget.
When the announcement about the Satyam plan to acquire Maytas Infrastructure was announced, a controversy emerged on three basic counts:
a) There was a debate about the valuation of Maytas equity in the deal, and the fact that Maytas is managed by family members of Satyam's promoters seemed to indicate that the deal was a plan to siphon out Satyam's cash balances to a family run firm.
b) FIIs insisted that there was little value in the diversification of an IT firm into the infrastructure sector, and that investors could independently diversify.
c) FIIs debated that there is absolutely no synergy between the operations of an IT services firm and an infrastructure company.
Given the nature of this controversy there was a daily news flow in the Indian financial press and media, in which it was portrayed that the Maytas deal is a serious flaw in terms of the corporate governance structure of Satyam. the promoters, holding very little equity stake in the Company were planning to make an overvalued investment in a family run firm in another sector, to the detriment of the Foreign and Domestic Institutional Investors in the Company.
At that point in time I had no view on Satyam. The reason for my confusion about the Satyam story was my macroeconomic view that the Indian Infrastructure Sector is a good buy. I must admit that I did not go through the details and check whether the valuation of Maytas equity in the Satyam deal was fair or not.
What followed the Satyam-Maytas deal controversy was a veritable campaign against the Satyam Board of Directors by Institutional Investors, mainly the Foreign Institutional Investors . Independent Directors on the Satyam Board were blamed for their irresponsibility/complicity is passing the resolution to acquire Maytas.
The Board meeting to pass the resolution was chaired by Dr. M. Rammohan Rao, who has a position at the Indian School of Business in Hyderabad.
Dr. M Rammohan Rao is best known for his tenure as the former Director of the Indian Institute of Management, Bangalore. Dr. Rao is a scholar in discrete mathematics and he has won several international academic awards and prizes in that area. He teaches the application of mathematical methods to financial derivatives. Dr. Rao was a full professor at the New York University prior to his tenure at the IIM-B.
Dr. Rao also chairs various high level Government Committee. For instance, he used to be on a Selection Committee for the post of Deputy Governor of the Reserve Bank of India. In the wake of the Satyam-Maytas controversy a Member of Parliament wrote, questioning the appropriateness of having Dr. Rao on such Committees. The financial media reported with glee a couple of days back that according to them a meeting of this Committee was delayed and Dr. Rao was excluded from the meeting.
Other independent Directors included Vinod Dham, who is widely regarded as the father of Intel Corporation's Pentium Chip program, Dr. Krishna Palepu and one other Dr. Mangalam, both Professors at Harvard, I think. Mr. Prasad, another independent director, is a former Cabinet Secretary to the Government of India.
With the exception of Mr. Prasad, all the independent Directors resigned from the Satyam Board in the wake of the mass media and political campaign launched by the Foreign Institutional Investors.
As this controversy developed FIIs approached a wide range of "strategic investors" to buy out the promoter stake in Satyam; IBM,Oracle,HCL Infotech,Mahindra Consulting are some of the names here. The Satyam stock plummeted due to the controversy but the strategic investors were still demanding lower valuations if they were to think of a management buy-in. In the melee, the World Bank released information that they had earlier blacklisted Satyam due to Satyam having bribed Bank Staff members in return for favorable vendor contracts.
The bottomline of the whole Satyam-Maytas controversy was that the promoters, led by Mr. Ramalinga Raju, should sell their equity stake in the Company and resign from the Board. According to FIIs, this would solve Satyam's 'Corporate Governance' problem and help improve the stock's valuation.
While the independent Directors appeared to stand by the promoters initially, The Economic Times reported on the day following the controversial Board meeting that Satyam's COO and some other high level executives had put in their papers just prior to the Maytas buyout decision. This actually reveals that the FIIs had some Company executives on their side.
Overall, as events developed, there seemed to be little chance that the Satyam promoter will be able to sustain its position on the Satyam Board.
In the light of this background, Ramalinga Raju's resignation letter should be read accurately. What Ramalinga Raju has done, is that he has diverted a huge amount, in the range of around Rs. 7,000 crore from the Company and then resigned, with a letter claiming that the money was never there.
Now it will be virtually impossible to trace that money. Regulators are free to go and investigate Price Waterhouse Coopers, the auditors of Satyam. PWC auditors will say that the money was there when they did their audit. This won't be easily believed. Similarly everybody left in the Company, several senior Government officials, and some of the other businessmen in India Inc will all come on TV and express shock and surprise, etc at this development. Aspersions will be cast on several other IT firms.
All this jaw boning will presumably amount to nothing. Satyam now needs to be valued without that cash on its books.
I'm expecting that Ramalinga Raju will find ways to route the Satyam money to Maytas, just as he originally intended. I would therefore advise private investors to go long on Maytas with a 2 year investment horizon. There is no futures and options trading available on Maytas on the NSE. Buy Maytas in delivery and wait patiently till the Satyam storm blows over.
Maytas won a big contract from Southern Railways yesterday. It's trading at slightly above its 52-week low levels today.

Satyameva Jayatey Part I: Fresh Unanticipated Panic Breaks out on the Nifty

2009-01-06T23:52:00.000-08:00

A word on the title for international readers. The word 'Satyam' means 'Truth' in ancient Sanskrit and the phrase 'Satyameva Jayatey' means 'Let the Truth Triumph', approximately.
At this writing there are few round numbers to report. Nifty is trading at around 2950 levels, down around 162 points from its previous close. Satyam Computers Ltd. is trading at around Rs.50, which is around 76% down from its close yesterday.
Mr. Ramalinga Raju, the principal promoter and outgoing Chairman of the Satyam Board, this morning resigned from the Company's Board and wrote this:
a resignation letter for the history books.
Update: I was going to continue to write about the letter and so on but I have some useful information for investors on the Satyam so I'm moving on to Part II now instead. There's a lot of information available on the Satyam numbers elsewhere.

revealed with deep regret that The Company's Balance Sheet as of September 30, 2008 contains:
1) a) $ 1050 million of inflated (non-existent) cash and bank balance as against $ 1117 million reflected in the books.
b) An accrued interest of $ 78.33 million which is non existent
c) An understated liability of $ 256.25 million on account of 'funds arranged by Mr. Raju'
2) An overstated debtor position of $ 102.08 as against $ 533.54 million reflected in the books.
To be continued ...

US Treasury fights in Sri Lanka's Uncivil War

2009-01-06T19:41:00.001-08:00

This post examines recent geopolitical developments in Sri Lanka to divine the financial dimensions of the ongoing war in that country. Sri Lanka is an island nation in the Indian Ocean, just south of India's southern coastline. Here's a link to The United States Ambassador to Sri Lanka, Mr. Blake's speech on the United States Department of State views on Sri Lanka at the University of Madras (Chennai) on October 24,2008.
According to Ambassador Blake's speech, sometime after November 2007, the United States Department of the Treasury designated the Tamils Rehabilitation Organization under Executive Order 13224, thereby freezing the TRO's assets in the US and prohibiting Americans from dealing with them. This was following an anti-terrorist investigation in which the Liberation Tigers of Tamil Eelam (LTTE) was linked with the TRO.
The official Department of State stand is to catalyze a political solution in Sri Lanka and establish a democratic government for all of Sri Lanka. It appears that the US has allowed the Sinhala Army to defeat the LTTE, mainly by choking off funding to the LTTE, in order to hasten the 'political solution'.
On January 01, 2009, offensive divisions of the Sinhala Army in the Wanni Theater of operations announced the imminent capture, within 48 hours, of the LTTE Capital of KilliNochi. Tiger propaganda would have it that KilliNochi was simply a 'ghost town', already evacuated by the Tigers before its capture. The Sinhala Army is now pursuing the capture of Velupillai Prabhakaran, the supreme leader of the Tigers.
Sri Lanka in 2007 was de facto an island with two nations on it. The North and North Eastern parts of Sri Lanka were controlled by the Tigers, while the rest of Sri Lanka was the actual Sinhala nation with its capital in Colombo. The Tigers had set up border control posts to delimit their territory. The Tigers had their own Army, Battle Tanks, a Sea Tiger navy fleet, and so on. Throughout the last few months of 2008, every week there were reports and announcements in the Indian media of miraculous successes of the Sinhala Army.
Some 200,000 Tamil civilians overall are reported to have been displaced, with massive uncounted civilian casualties of Tamils caught in the crossfire between the Sinhala forces and the Tiger strongholds. Both New Delhi and the international press have maintained a studied silence on the issue. There has been no Indian intervention, with the exception of one ship from India containing humanitarian relief supplies for the Tamils. There has been no discussion on this issue at the United Nations; no proposals for a ceasefire; and no talk of any outside military intervention to stop the violence.
My analysis is that the international silence on the ongoing war in Sri Lanka is closely connected with Sri Lanka's Natural Gas Reserves, The European concerns over Russian Natural Gas supplies and Gazprom's recent decision to cut off NG supplies to Ukraine.
Most importantly, all this probably has profound implications for what is really going on behind the scenes in the unfolding battle between the Reliance Group Ambani brothers over the new Natural Gas finds in the Krishna Godavari basin in India.

Important update based on Brad's comment

2009-01-06T18:50:00.000-08:00

Brad Setser points out that India doesn't peg to the dollar as much as China; India's forex reserves are falling, (this is me: while China's forex reserves are probably rising).
So we need to understand that the only really significant support for the US dollar's status as a central bank reserve currency comes from China, among state actors.
I think there is some risk that the US dollar can in the medium term lose its status as a central bank forex reserve currency.

Reserve Currency Status of the US Dollar in 2009

2009-01-06T09:58:00.000-08:00

In my humble opinion there is a significant risk that the US dollar will lose its reserve currency status. However my view is that at worst this can happen gradually over a period of time rather than in a sudden manner.
The recent debate around the reserve currency status of the US dollar must be examined in terms of different dimensions that impact this status and also from the perspective of various private and state actors who influence it.
George Soros in his March 2008 book "The Credit Crisis of 2008" predicted the end of an era and the collapse of the US dollar. He recounted that in January 2008 he went massively short on the US Dollar and long on the Indian stock market. Both the positions were losers and his firm,according to the book, "took it on the chin". Marc Faber, Jim Rogers, Peter Schiff and perhaps Stephen Schwarzman are other US dollar bears.
If any other country on earth had been in the same macro economic situation as the United States was in 2008, its currency would have been subjected to a massive speculative attack from private currency speculators. This would have begun with a tremendous build up of short positions on the currency in the forex derivatives market. The fact that the US dollar escaped a successful attack from currency speculators in 2008 does not neccessarily augur that it will indefinitely retain its unique role in international trade as well as its exorbitant previlege to run painless fiscal deficits.
In 2008 several state actors have openly indicated a policy shift in the composition of their central bank foreign exchange reserves. Iran's President Ahmedinijad made a self congratulatory speech in which he claimed that his decision to shift over from the USD to the EUR as the Iranian reserve currency was apt both from an investment perspective as well as from a political perspective. The German Foreign Minister Peer Steinbruck gave an interview in which he predicted that future forex reserves would move towards a combination of the US dollar, the Euro, the Japanese Yen and the Chinese Renminbi. Nicholas Sarkozy of France indicated that "the US Dollar is not the only currency in the world" in his statements prior to the G-20 summit. Though Japan continued to maintain strong support for USD denomination of international trade, Japan made a request to the US Treasury to issue Yen denominated debt securities to the Bank of Japan.
Given the political enmity with Venezuela's Chavez and Russia's Putin, those two countries will probably welcome any chance to ensure the demise of the US Dollar.
The only prominent supporters of the US dollar are emerging market economies like China and India. These countries are compelled to peg their currency to the US dollar since significant percentages of their population is directly dependent for their employment on a sustainable profitability of their export sectors.
Trade protectionism is another aspect which impacts the US dollar. Given Obama's recent focus on data from manufacturing and unemployment statistics in some of his comments, there is widespread speculation that the new administration is likely to pursue protectionist policies. If the level of export demand for emerging market output becomes unsustainably low due to protectionism the remaining state supporters of the US dollar reserve currency status will change their view.
If the Obama Administration does not resort to severe trade protectionism it is quite likely that 2009 will see the US dollar gradually weakening against major world currencies, rather than undergoing a sudden collapse.
However in this analysis we have to recognize that a lot depends on the relevant emerging market economies wishing to sustain employment levels in the medium term. In the longer term, it is difficult to see how or why a country like China, for instance, would want to continue the policy of accumulating US Treasury bonds in lieu of real goods.

What is Dr. Brad Setser missing? Part I: Seeds

2009-01-06T07:55:00.000-08:00

That's the question at the end of Brad's post on issues to be watched in 2009.
Seeds, for one. Seeds?
Most of the economics discussions in 2008 seem to have paid little attention to the African continent. Food prices skyrocketed more than 95% during the credit crisis of 2008. Several countries, Ethiopia for instance, are facing a severe food crisis. There have been "food riots" during 2008 in places like Somalia and Zimbabwe.
The scientific/secular argument is that in the face of the food crisis, genetically modified seeds that provide a higher yield should be used to increase the productivity of agriculture; thereby reduce costs and prices of food; and thereby help alleviate the impact of the credit crisis on least developed countries. Many African country regimes, on the other hand, perceive genetically modified seeds as a United States foreign policy tool. Their apprehension is that the genetically modified seeds are configured to provide vastly decresing yields with every succeeding generation. What this means is that farmers always have to purchase new supplies of seeds from the foreign agri-biotech companies and effective sanctions can be implemented through restricting future sales of seeds from American firms to certain African countries.
This is the real theme of the Council on Foreign Relations 'Politics of Hunger' report, though it doesn't say so in so many words.
I'd like to report an unconfirmed speculative rumor that Merill Lynch has made a huge investment in a company called Biotor, or whatever its name is, bang in the middle or the tail end of the whole 2008 financial disaster, as it may turn out to be. Again I'm constrained to check the rest of the details of this story out and would appreciate any corrections/additional information/additions.

Fog around the Santa Claus Rally

2009-01-06T02:54:00.000-08:00

Why is it hard to predict the Nifty level over a period of say one month or so?

On Nov 20 2008, Nifty was at a trough of around 2500. By Jan 05, it closed at 3100 plus. This post tries to explain the reasons for what’s commonly been called the December 2008 Santa Claus Nifty Rally. (During this time visibility was very low in Delhi and several flights were cancelled due to dense fog). FII and DII turnover was at very low levels. Overall market turnover dropped precipitously during the holiday season, though the market continued to rally. Several commentators have mentioned that the December 2008 rally was led by high net individuals (HNI s) and retail investors.
Let’s examine this in its wider context and try to understand what’s really happening. You will observe the following typical sequence in the stock market. The economy is booming. Unemployment is at historical lows. Consumption is strong. Credit is flowing freely. Productivity is increasing. There are no major wars or conflicts. The stock market suddenly undergoes a precipitous fall. Various sectors decline. You get bears coming on TV and giving meaningless reasons why the market is considered to be “overvalued” and predicting a dire correction. After some time the market goes up again, and reaches ever higher levels. This behavior is called as an “intermediate downtrend in a bull market”.
Similarly you’ve observed several rallies since January 2008. The economy is down. People are dependent on government stimulus spending to make profits. Credit is frozen. Unemployment is at historic highs. The market suddenly goes up 20% or more in a month. This completely funny behavior of the stock market is called as “an intermediate uptrend in a bear market” or simply as a “bear market rally”.
Technical analysis textbooks will tell you that these “intermediate trends” last anywhere from 3 weeks to 3 months. The corrections are usually shorter and sharper than the rallies. So far I’ve never actually come across a believable and consistent explanation as to what causes these intermediate trends.
Of course there are many theories about it, from the Elliott Wave theory to the Random Walk Hypothesis, to the Business Cycle theory, stretching across the various areas of technical analysis, capital market theory and macroeconomics. None of the theories have genuine predictive value and none of them suggest ways and means to remedy this problem.
The reason for these trends might very well be what is known as “operator play”. A stock market operator is a participant who has access to a large amount of capital, usually in the form of short term credit. This participant is able to manipulate and influence prices in a particular counter and segment. Typically the influence on prices is aided by misinformation campaigns which create increased speculative interest in the counter.
Observation of the December 2008 rally appears to indicate significantly high levels of operator play in various counters.
This is why trying to predict the Nifty levels in a particular series using the traditional methods of technical analysis, fundamental equity analysis and macroeconomic analysis can be ineffective.

Nifty and the Global Economy

2009-01-06T01:37:00.000-08:00

The global deleveraging process is still on. According to posts on the Calculated Risk blog, commercial real estate firms, retail chains, etc are facing significant financial problems both in the US and in the UK. On December 17, 2008 the Fed made an announcement revising the target fed funds rate to zero and indicating a policy of further monetary expansion through quantitative easing. The recent uptrend in global markets appears to be on the back of that announcement. Globally, Q3 earnings are going to be released and economic data hasn’t been encouraging since that announcement. After Obama’s inauguration on January 20, 2009 announcements regarding the US government stimulus package are expected. Global economies are in a recession and economic expansion can definitely not be expected during Calendar Year 2009.
Around 32% of India’s GDP comes from exports. Around 15% of that is merchandise exports. Export markets are severely affected by low levels of aggregate demand worldwide, apart from operational issues such as the availability of credit. Given the Q3 earnings releases in India and similar data on financial performance worldwide, all the news and cues from today onwards till January 20 can be expected to be bearish for the Nifty.

Q3 Earnings and the Nifty

2009-01-06T01:10:00.001-08:00

Q3 Earnings and the Nifty:
Earnings releases are expected to begin later this week and early next week. Several analysts have an opinion that the expectations from the Q3 earnings are already priced into the Nifty.
Advance tax numbers have been released. Commercial vehicle sales data has been released. November trade data shows merchandise exports declining at a decreasing rate and non-oil imports increasing at a decreasing rate. Given the information already available there are several expectations related to Q3 earnings.
The auto sector, auto ancillaries, real estate, metals, etc are expected to show very bad results for Q3. The IT services sector will show severe topline weakness, combined with higher margins from layoffs of workers on bench and a stronger dollar; it’s possible that dollar hedges resulted in Treasury losses for them.
My opinion is that the earnings are not fully priced into the Nifty. Once the results are actually out, there will be a bearish impact on Nifty levels. Consider the example of how bullish news flow impacts the market. Before the Friday evening announcement of a second government stimulus package there were already expectations around it. The RBI’s 100 basis point cut in reverse repo rate to 4%, and 50 basis point cut in the Cash Reserve Ratio did act as a positive surprise for the market. At the same time, the real estate, infrastructure, exports, sectors were disappointed with the stimulus package and more was expected on those fronts. So the actual news was different from what was expected both ways. The market rallied yesterday with higher volumes on news of the stimulus package. My view is that the simpler story applies. Though the market was expecting bullish news, when that news was actually out; it rallied.
Today the market is adjusting to Q3 earnings expectations. Once the data is actually out, there will be a Nifty fall.
Given the technical analysis of the Nifty, that fall might take us below 2500 to the next trough, possibly to around 2200 levels.

Technical Analysis of the Nifty

2009-01-06T00:39:00.000-08:00

The Nifty peak was around 6300 levels, in January 2008. The troughs were hit in October and once again on Nov 20 2008, at around 2500 levels. Between the October and November troughs the peak was at around 3150 levels. There’s been a up trend from November 20 onwards. Technical analysts believe that a bear market rally is one in which the successive peak is lower than the previous peak. So the technical view expressed, for instance, by Rajat K Bose is that unless the Nifty closes above the 3150 level at high volumes the current up trend should be viewed as a bear market rally. The other characteristic of a bear market rally is that it is followed by a sharp downtrend, in which the next trough is lower than the previous trough. Since the previous trough was around 2500, if the current uptrend were to break then the next trough is likely to be below 2500.
Technical analysts also measure volumes and market breadth. The Nifty rally all the way till yesterday (Dec 05) was marked by low volumes. Yesterday volumes were higher and the Nifty was up further from the Friday close.
Today’s view from Rajat Bose is that traders need to watch out for the 3045 level. Nifty has resistance at 3045 and if that is breached it could signal the start of an intermediate downtrend, which might possibly take the Nifty below 2500. Similarly it stands to reason that if the Nifty crosses 3150 levels at high volumes that would signal a reversal of the downtrend all the way since January 2008.

The Oil Route and the Gaza Strip Conflict

2009-01-05T04:55:00.000-08:00

There is a plan to transport oil from the Caspain Sea/South Caucasus region to the Mediterranean port of Ceyhan, and thence to the Red Sea port of Eilat, through to supply markets in East Asia. Hamas appears to have been targeting an oil pipeline inside Israel with rocket attacks to disrupt this plan, and this has led to the Israeli invasion and planned occupation of the Gaza strip.
This post has nothing to do with nationalism, religion, or any civil society movements, etc. All the analysis and information here is from public sources of information. This analysis is intended to highlight the connections between the geopolitical developments on the Gaza strip and the financial markets. Contrary to popular press coverage, this is an ongoing conflict which has fairly clear financial causes and consequences. Interested private investors are advised to draw appropriate inferences to their advantage.
Since 2005, 5000 rockets have been fired into Southern Israel, causing 11 casualties amongst Israeli citizens so far. This statistic is from a statement of an Isreali military spokesperson on CNN yesterday. The Israeli military bombed Gaza City over 8 days and yesterday launched a ground offensive into the Gaza strip. Hamas continues to fire more rockets into Israel. In Gaza city there are civilian casualties and there is reportedly destruction of schools, hospitals, mosques, and all kinds of other buildings etc. Supply of electricity and the working of mobile phones has been disrupted. Shops are closed. Landline phones and radios appear to be working.
Israel has stated that the civilian population of the Gaza strip is not its enemy. Israel has assured that humanitarian relief is being provided. There have been pamphlets from the Israeli High Command adivising civilians to evacuate the Gaza strip and allow operations against the Hamas dominated areas. Washington has maintained at the United Nations that "a meaningful ceasefire is impossible at this stage". The Arab League has called for a cessation of hostilities. There have been popular protests against the invasion of Gaza all across various Arab countries and a very large protest in London as well.
It appears that the target of the rocket attacks by the Hamas were not civilians in highly populated areas in Israel. Rather it appears that the target has been the Ashkelon-Eilat oil pipeline inside Israel. Similarly it appears that the target of the Israeli Military is the disruption and prevention of these rocket attacks and not the civilians inside Gaza.
The Baku-Tiblisi-Ceyhan oil pipeline pumps oil from Azerbaijan in the Caspian Sea region to the Mediterranean sea port of Ceyhan in Turkey. More than 30% of this pipeline is owned by British Petroleum. The Ashkelon Eilat pipeline is owned by the Eilat Ashkelon Pipeline Company which began as a joint venture of the Israeli Government and the Teheran government. Since the Islamic revolution Teheran seems to have dropped out of the pipeline ventures of EAPC.
The BTC pipeline transports oil from the Caspian Sea to the Mediterranean and opens the way to supply Europe with Central Asian oil. In 2003 a reverse flow of oil from Ashkelon to the Red Sea port of Eilat was completed successfully. By transporting oil from the Turkish port of Ceyhan to Ashkelon, oil can then be pumped to Eilat and then transported across the Red Sea to the Arabian Sea in order to supply the markets in East Asia.
China already has another new pipeline that runs from the Kashagan oil fields (in Kazakhstan, South Caucasus region) east into China. So India seems to be the primary target market for the oil from the Caspian Sea through this route.
I'm yet to work out the details of the rest of this story. Chevron recently renewed the plan to buy equity stake in Reliance Petroleum. Indian Oil Corporation was a close partner of Istanbul in the construction of the Baku-Tblisi-Ceyhan pipeline.
Additional information/comments/corrections are most welcome.

From Brad Setser's Analysis of China's Exports

2009-01-02T00:12:00.000-08:00

My comment on Brad's post :
(I might be making some corrections/additions to this later)

I find Brad's analysis very interesting from an Indian market perspective. Thanks a lot Brad for your insightful post. The Nifty has rallied from its October low of around 2500 to around 3050 levels at this writing.Over the last 4 trading days volumes have been low (presumably affected by the holiday season) and the rally has proceeded in the range upwards from around 2810 to 3050 in these 4 days. The November trade data for the Indian economy is out. It shows a contraction of around 9% plus in merchandise exports in Nov 2009 and an increase of around 3%plus in non oil-imports. India's fiscal deficit and current account deficit are both widening and forex reserves are falling.Today the Govt. of India is expected to make an announcement regarding further stimulus programs after market hours. Speculation in the marketplace is around the following factors:1) The Govt. stimulus program is expected to be bullish.2) Earnings for the Sep-Dec Quarter will start to be announced around 10 days from now.This is expected to have a negative effect on market sentiment.3) Global cues are being closely watched. FII buying has begun in Dec 2008 after a selling trend throughout 2008. However, if you total up FII turnover from the previous trough onwards you get a negative total (i.e. more sales than purchases)Given your analysis that "the global environment is changing in ways that will make it harder for China to avoid a sharp downturn in its exports no matter what China does" I believe it applies to India's merchandise exports as well.Merchandise exports are around 15% of India's GDP and exports total up to around 32% of GDP overall. Your post reinforces my bearish outlook on the Nifty for the January series.At the same time you have to remember the recent rally on the Nifty has been led largely by HNIs and retail investors rather than institutional buying.The current bear market rally can either be artificially extended beyond the earnings season, or there could be a natural collapse to re - test the October lows of 2500.

Whither Nifty in January 2009?

2009-01-01T01:14:00.000-08:00

In January Nifty is likely to make a break either upwards or downwards. Nifty is likely to test the October lows of 2500 if the move is downwards. If the move is upwards you could expect a trading range above 3250.
Technical Analysis shows a consolidation during the last 2 trading days of 2008 and today. This consolidation is below the previous peak of 3150, in the 2990 range. At this writing Nifty has risen above the 3000 mark and is trading at around 3030 levels.
One of the limitations of Technical Analysis is that it tends to show a movement once it has started rather than predict a movement before it starts.
My bias is a bearish one on the Nifty but at the same time I don't rule out a bear market rally in January 2009.