Article by Jorge Nascimento Rodrigues
_ Contributor for Expressoweekly newspaper, Lisbon. Editor of Janelanaweb.com
_ Co-author of Business Minds and Pioneers of Globalization
The first ingredient appears on the other side of the world, Asia, and has to do, strangely, with… the price of pork in China.
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The price of live pork, in the second largest economy, climbed in June to €2/kilogram, exceeding the record in April 2008. Chinese pig farmers can rub their hands in glee, but on the table of Chinese, pork, a basic ingredient of his diet, increased to €3/kilogram. According to China Daily, this is a 57.1% increase in the price of pork, in annual terms. The monthly change from May to June was 11.4% compared to 2.6% between April and May. Overall, food prices increased more than 14% in twelve months.
Chinese “Tiger” inflation at 6.4%
The nervousness took hold of Beijing State Council, which has so much horror of inflation as of dissidents. What this means is that the Chinese government are failing to tame the “tiger” (as Prime Minister Wen Jiabao called) of inflation. According to China Daily, inflation has reached 6.4% in June, well above the official target of 4%. The recent rise is impressive: in June 2010, the annual price index was 2.9%.
To tame the “tiger” China has to cool the economy by controlling the credit; bad loans have soared to alarming levels. Moody’s in Singapore revealed that bad loans could reach 8 to 12% and that the Chinese auditing entity may have underestimated in 1/3 the level of the Chinese banking system loans to local governments. The People’s Bank of China – central bank – decided to increase by 0.25 percentage points the interest rate at 1 year of lending and the rate of return on deposits (encouraging savings). It is the fifth time since the end of the economic crisis and the 3rd time this year. The goal is that inflation falls below 5% from October.
But these measures may not solve the problem, since “hot money” continues to run in China. Investors and speculators can get access to interest rates lower than the 6.56 % in China: close to 0% in the U.S., 0.5% in England and 1.5% in the Euro area.
Chinese economists forecast that the growth rate falls from the International Monetary Fund (IMF) official number, 9.6% to 8.5%, this year and next. This means that a domino effect can occur in combination with the possibility of exports stagnation, one of the two engines of the economy, alongside rampant construction.
Growth in the first quarter this year was 9.7% over the same quarter last year and the pace in the second quarter fell to 9.5%. In terms of semesters, the Chinese economy grew 9.6% in annualized terms in this first half of 2011, against 11.1% in the same period of 2010.
But Michael Pettis, professor at the Guanghua School of Management at Beijing University, is cautious: “I think that instead of a hard landing of the Chinese economy, we will assist to a long landing” and admits that the persistence of inflation may “not even be a bad thing in long term, as will strengthen the reformist faction in China, “particularly after the changing of the guard in the party, the presidency and the government, that is going to happen next year.
As the Pacific butterfly
You must be thinking: what Chinese pork has to do with world economy? Like the butterfly that flaps its wings in the Pacific and causes a tornado across the world, in Louisiana, the rise in pork prices turned out to be linked to the slowdown of the world’s economic locomotive. And if China slows down, the world economy and international trade could suffer from that.
After a growth of 5.1% last year, the world will grow less this year and next, 4.3% and 4.5% respectively, according to figures released in June update by the IMF World Economic Outlook. But more troubling is the slowdown in international trade – from an increase of 12% in 2010 to 8.2% this year and 6.7% next year.
The same problem with inflation is occurring in India, the other major emerging power. inflation is “endemic” in this country, tells us Edward Hugh, a specialist based in Aruba, Netherlands Antilles, editor of the India Economy Blog. Indian Inflation is above 9% and the goal outlined by the governor of the Reserve Bank of India (central bank) is to decrease to 6% in 2012, which will imply a cooling of the economy to a level of 8% per year. IMF projects that inflation would fall even below this level in 2012. And you can add to this another structural problem: deficit of around 10% of GDP.
To Edward Hugh, “hot money” is what ignited India and China economies: short-term money that flooded the large emerging countries, technically referred to as “volatile capital.” If there is a sudden deterioration in the feeling of risk caused by the European crisis or the doubts in the United States, Asia will be very exposed.
Red alert in Europe
In Europe it’s the wind that blows from the Aegean Sea that shakes the entire continent. Jean-Claude Trichet, European Central Bank president, said recently that “personally” he thinks that we have entered in a state of red alert. The repercussions of a re-structuring, even “soft”, of the debt of Athens, still have no clear outlines.
But the doubt emerged, particularly in the heart of the Eurozone. The 290 Germans analysts and institutional investors surveyed by the Center for European Economic Research (ZEW) radically changed their “feeling” over the next six months. The ZEW index had a twist: from 3.1 positive in May to 9 negative in June. The president of the ZEW concluded that “the German economic boom may weaken in coming months.” And if that happens, it is the locomotive of the European Union and the fourth largest economy in the world catching a flu.
“A major financial crash in Europe – Greece default or the need for an urgent rescue in Spain – could imply an escalation of the risk sentiment, as happened in the fall of 2008, which may cause contagion to Asia. And that could generate a serious double-dip [recession] in Asia, “says Edward Hugh.
Although the focus of media attention is in the trio Greece, Portugal and Ireland, already under the troika (EU / IMF / ECB) rescue plans, and with very high levels of default risk, exceeding 50%, the real “elephants” in the porcelain store in the Eurozone, are Spain and Italy.
The two countries are those with the highest net value of credit default swaps associated to its sovereign debt, and in recent weeks, the risk of default and yields on bonds (in the secondary market) have risen. That value is like a gauge of contagion. Italy is on top with a net worth of 23.7 billion dollars in CDS’s and Spain is a close third place, after France, with about 18.4 billion U.S. dollars.
Markit draws attention to the evolution of the CDS on these two large economies – Italy is the 8th largest economy in the world and Spain the 12th (2010 GDP).
Markit notification came in the right moment. The climbing, never seen before, on the default risk and in Treasury bond yields of the two countries – and particularly on Monday July 11 – just confirmed it.
The double-dip recession in the U.S. may have already begun
In the U.S. there is a growing discomfort. A recovery that does not resume. Ben Bernanke, chairman of the Federal Reserve, in his speech in June at the International Monetary Conference in Atlanta, said we were in front of a “spasmodic and frustrating” economic recovery.
The Fed itself confirmed in June that lowered the growth forecast for the United States, the world’s largest economy, from 3% to the interval between 2.7% and 2.9%. And the IMF went on to speak of a “smooth slow” with “increased risk”.
The June employment numbers (excluding agriculture) released on July 8th by the Bureau of Labor Statistics, were a cold shower. Statistics revealed that over the last nine months, June was one in which fewer jobs were created, only 18 000, worse than the most pessimistic forecast, made by Reuters. The unemployment rate is at 9.2%, more than 14 million Americans. The employment is 7 million below the level on January 2008. According to Reuters, at the pace of the last three months it will take “seven years to replace the jobs lost” to the crisis.
One of the most significant indicators about the poor progress of the U.S. economy was underlined by Jeff Nielson, Bullion Bulls Canada. Nobody talks about it, says Nielson, but the picture is raw and “the numbers cannot be dodged” by politicians or the bureaucracy: the income tax deducted at source are in sharp decline since May 17. According to Lee Adler, editor of The Wall Street Examiner, the barometer may indicate that “the U.S. economy went into recession,” more than a month and a half ago.
Despite the effective devaluation of the dollar since early 2009, intended to “improve external competitiveness,” the negative net worth of exports of goods and services of the United States has worsened recently, according to the Department of Commerce. America may be starting to suffer a generational low productivity stage. Alan Greenspan, former Federal Reserve chairman, said in an interview with The Globalist, that there are clear indications “that the productivity of the young part of the workforce is in decline when compared to what had been reached by baby boomers [the generation born after World War II until 1964].”
500 billion of U.S. debt in August
The debt ceiling has been reached in May. The question now is the raise of the debt ceiling or a default on U.S. debt.
Timothy Geithner, U.S. Treasury Secretary, said, on July 10th, on “Face the Nation”, that in August there are 500 billion dollars of U.S. debt that will have to be rolled over. In the first week of August 87 billion USD are at stake.
The problem this time is the Republicans, pushing the rope to the limit. Some have even admitted the hypothesis of a “default for a few days,” he told Reuters.
Geithner was clear on NBC: “There is no option to delay, there is no creative financial option.” An agreement has to be achieved by the end of next week, so that Congress has time to pass legislation before the deadline on the first week of August.
Even The Economist is beating on the Republicans. In an article, with unusual harshness, the British magazine, was alarmed by the fact that “Republicans are pushing things too far.” The title of the article, published on July 7th, speaks for itself: “Shame on them”. And speaking directly to the Republicans, “A gamble where you bet your country’s good name”.
Mark Thoma, an economics professor at the University of Oregon, summarized the situation very hard in an article published in The Tax Times last week, denouncing the way the Republicans, since they won the majority in the House of Representatives, have pursued a strategy of stoke uncertainty into the economy, holding the country hostage by an ideological struggle.” The Tea Party – led by Eric Cantor (Boehner’s rival in the Republican party) does not want the debt ceiling to be raised.”
Agreement of mutual suicide
Several second-tier Chinese officials have said that Republicans are “playing with fire”, summarizing how the world watches to what happens in the House of Representatives in Washington. The Chinese have a clear sense that they are tied to an “agreement of mutual suicide” if things go sour, as last week, told former Secretary of State Henry Kissinger in an interview with German newspaper Der Spiegel.
To close the bouquet, the rating agency Fitch Ratings (from Fitch Group, controlled in 60% by French holding company Fimalac Marc Lacharriere and in 20% by the American media conglomerate Hearst) said clearly that the United States are at risk, in August, of a restricted default, a technical word that frightened financial markets.
On July 13 it was time for Moody’s to repeat a prior threat. That they would revise the triple-A note if the U.S. Administration and Congress do not come to an agreement and the federal debt ceiling is not raised, running the risk of a “temporary default” in early August.
The speculative interest for the American debt can be seen in what is happening in the credit default swaps market. In the last twelve months, the net value of the CDS’s that grew more – over 136.4% – was of the U.S., according to ZeroHedge, based on data from the Depository Trust & Clearing Corporation.
A preliminary test of investor’s behaviour occurred July 12th, when the Treasury auctioned 32 billion dollars in three years Treasury bills. Demand was high and the yield remained low. The next auction with this maturity will be in August.
With the end of the second program of “quantitative easing” pursued by the Federal Reserve (Fed), debt holders have no longer the certainty that “there’s a buyer in the secondary market, after Auction [primary market]” noted Reuters.
The mechanism has injected 600 billion dollars in the market between November 2010 and June 30, 2011, allowing the circuit to keep rolling. The U.S. Treasury issued debt, the primary market dealers took it, and then you had dynamic in the secondary market because the Fed was there to buy the bonds at a higher price. During QE2, and for a few weeks, the Federal Reserve hold operations almost every day.
No way the US will default in its debt
But for a number of economists and analysts interviewed by janelanaweb.com this default stress is wrong.
The analyst Peter Cohan says that all this anxiety stems primarily from “ignorance and fear.” The probability of a technical default is 2%, says Cohan. The risk of default in a five years horizon, reflecting the temperature in the markets for credit default swaps tied to the U.S. debt is less than 5% (compared with 84% in Greece and 59% for Portugal), according to the latest data from CMA DataVision.
Cohan also stresses that “even if the debt ceiling is not raised until August 2nd, the United States can still get 60% of their income from tax revenue.”
Nobel Prize Winner Robert Fogel – the “father of cliometry” – stated in the first week of July when I interviewed him about the world situation: “There is not the slightest chance that the US will default on any part of the US debt, even without a raising of the debt ceiling. The revenue is more than enough to cover US commitments to its bondholders and still have substantial funds for various welfare programs. The central point at issue between Republicans and Democrats is the Republican contention that they want to reduce the share of government spending of GDP, which rose from 20% under President Bush to 25% under President Obama. The likelihood is that, in the end, some compromise will be reached.”
Also long investment banker and risk manager James G. Rickards, senior managing director for Market Intelligence at Omnis, says that “there may be a debt ceiling crisis, but there will not be a default.” “The US can always use its cash flow to pay interest and principal on its bonds even if other obligations are unpaid. And the US can always print money and use the Fed to buy more bonds. So, as a pratical matter, there is no way the US will default on its debt. The real problem for investors in US bonds is not default, but inflation, which reduces the real value of bonds.”
But Peter Cohan admits that the political environment may deteriorate in the U.S. Congress and they could be opening a Pandora’s Box. David Kotok, from Cumberland Advisors, is even more blunt: “The United States will not enter into default, even for a day. Any politician who advocates it should be impeached.”
Behind the scenes it is said that President Obama and John Boehner, have reached an agreement behind closed doors in a “secret meeting” during July 2-3 weekend, according to The New York Times. Obama stood up to a plan to cut federal spending that could reach $ 4 billion (27% of last year GDP) over the next ten years.
However, on the July 9-10 weekend, The New York Times reported that a second round of talks took place in the White House after the Republican Speaker declared on Saturday that he was abandoning the discussion of the 4 billion package and was returning to the platform negotiated with Vice President Joseph Biden.
Other analysts agree that the Treasury is preparing a plan B if the debt ceiling is not raised before the moment of truth, in August. One hypothesis would be the U.S. administration say that the ceiling is unconstitutional under the 14th Amendment of the Constitution. But Obama has said he would not go that far. This mess over the debt crisis could turn to a constitutional crisis and a sudden deterioration of the political situation in America. The collision of two tornadoes.
PIGS ‘R’ U.S.
The big risk of this summer is that the convergence of these negative trends causes the appearance of some “black swan”, still unpredictable.
In the meantime, the French forecasting think-tank LEAP, directed by Franck Biancheri in Paris, has warned that we have entered a second phase of the crisis, “cleaning” the “trash” accumulated in sovereign debt. The risk is that the wave from the Euro area will eventually touch the United States and United Kingdom.
And when it touches these two shrines, the perfect storm would have formed. There are not just billions, but trillions of dollars at stake, says the LEAP.
It was the British historian Niall Ferguson, who lives in the United States, which summed up the situation before an American audience shocked, “PIGS ‘R’ U.S.”. And said he did not use that title in an article in the Financial Times because the editor would not agree.
@2011, English Edition by JPO, LISWIRES.com
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