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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (24586)	2/28/2005 2:03:45 PM
From: patron_anejo_por_favor	Respond to of 116555

ROTFL! That one's going on his wall over his desk!<G/NG>

To: ild who wrote (24586)	2/28/2005 2:29:07 PM
From: mishedlo	Read Replies (1) \| Respond to of 116555

Why the Long Bond Isn't coming back [This seems like a good explanation - mish] U.S.: The Name is Bond -- "Long" Bond David Greenlaw (New York) On October 31, 2001, former US Treasury Undersecretary Peter Fisher announced that issuance of the 30-year bond would be suspended. At that time, bonds with more than 10 years remaining maturity accounted for nearly 18% of publicly held Treasury debt outstanding. Today the long end (excluding TIPS) represents less than 12% of the market. The narrowing of the 10’s-30’s spread over the past few months has led to renewed speculation that the Treasury Department may soon resume issuance of 30-year bonds. From mid 2002 through late 2004, the 10’s-30’s spread held within a range of 75 bp to 110 bp. However, in the past four months the spread has steadily narrowed to around 40 bp. Why the big move? Even though Fed Chairman Greenspan omitted pension fund demand as a possible explanation for the low-yield “conundrum,” this factor certainly appears to have helped support the long end of the bond market of late. My colleagues Richard Berner and Trevor Harris addressed the pension topic in great detail in a piece entitled “Pension Missiles: Is the Cure Worse than the Disease” (March 25, 2004) and extended the analysis following the release of the latest Bush administration pension reform proposal (see “Financial Market Implications of Pension Reform” in the January 18 edition of the Global Economic Forum). They concluded that pension reform could prompt a significant reallocation out of equities into bonds – to the tune of $650 billion. Moreover, the portfolio adjustment “could also entail a major increase in duration.” Of course, enactment of meaningful pension reform is still highly uncertain – a similar legislative initiative on the part of the Bush administration back in 2001 went nowhere. Still, even in the absence of major regulatory change, there appears to be a need to alter the portfolio composition of the nearly $4 trillion of assets that resided in public and private defined-benefit pension plans at the end of 2004. The market’s focus on the potential for massive flows into long-dated Treasuries – as opposed to the onset of actual buying by pension funds – appears to have played an important role in the recent flattening of the 10’s-30’s spread. Will the Treasury respond by resuming issuance of the 30-year bond? In order to address this question, it is important to understand the motivation for the elimination of the long bond. According to Treasury Department officials, the decision was made in accordance with the primary objective of debt management – to achieve the lowest-cost financing over time. In the view of Fisher and his staff, continued issuance of 30-year bonds was costly for two main reasons. First, it limited the Treasury’s flexibility. It was becoming increasing evident that the federal government’s finances were volatile and very difficult to predict. The budget swung from deficit to surplus much more rapidly than anyone had anticipated during the late-1990s. The buyback operations conducted during the surplus years were an expensive form of cash management. The Treasury determined that it could achieve greater flexibility by reducing the average maturity of the outstanding debt, and continued issuance of long bonds made it difficult to move in this direction. The second justification for the suspension of the bond was more directly related to a determination that long bond issuance was costly. Treasury officials observed that the yield curve was upward sloping over time, on average. The federal government is very different from a private corporation that might find it advantageous to pay up a little bit for the safety of locking in fixed funding for a long period of time. The Treasury is a frequent issuer with zero credit risk dealing in an extremely large and liquid market with a broad range of investor classes. Thus, unless the government attempts to engage in market timing – a practice that a long history of Treasury debt managers from both Republican and Democratic administrations has deemed to be extremely unwise –it makes no sense to pay the term premium embodied in issuing long-term debt. Of course, this line of reasoning raises the question of why the Treasury doesn’t confine its issuance to the very front end of the curve – say, by rolling over $3 trillion or so of short-dated bills every week. This is an interesting counterargument although it is obviously a bit extreme. The Treasury can maintain large, liquid issues out to 10 years and still achieve the target average maturity (somewhere around 3 years) that provides the desired flexibility Although former Treasury Undersecretary Peter Fisher, who appeared to be the chief proponent of eliminating bond issuance, has moved on to the private sector, the current debt management team has consistently backed this decision. Indeed, Tim Bitsberger, the current head of debt management, has offered strong public support for the suspension of bond issuance on numerous occasions. For example, in presentations delivered to investor groups in Philadelphia and New York in late 2003, Bitsberger concluded that issuance of long bonds “does not meet our criteria for achieving the lowest borrowing cost over time.” Indeed, as recently as this past Wednesday – the day that France auctioned a 50-year OAT – Bitsberger made the following statement during a brief press interview: “We view our current issuance calendar as being very flexible in being able to handle the variety of fiscal outcome. We’re very confident that we don’t need to make any changes to our issuance calendar at this point.” From our standpoint, two things need to happen to change the Treasury Department’s position. First, the administration has to be ready to concede that there will be a need to finance fairly sizable budget gaps for an extended period of time. This would reduce the need for short-run flexibility. While such a declaration would certainly appear to be realistic at this point, it may not be politically palatable. Second, the 10’s-30’s portion of the yield curve must invert and appear likely to stay that way for an extended period. In such an environment, the resumption of bond issuance would be perfectly consistent with the objective of lowest cost financing. In the past couple of weeks, portfolio managers have been publicly urging the Treasury to bring back the bond in order to meet pension-related demand (for example, see the Current Yield column in the February issue of Barron’s and the Wall Street Journal Credit Markets column of February 24). But, there is little evidence at this point of any abnormal compression of the long end of the curve related to pension fund demand. Indeed, the 10’s-30’s spread is somewhat wider than might be expected from a historical standpoint. Using monthly average yield data published in the Fed’s H15 report from 1977 (when the Treasury first started offering a wide range of maturities on a regular basis) through the end of 2001 (when the Treasury ceased issuance of 30-year bonds), we ran a simple regression of the difference between the yield on 30-year bonds and 10-year notes and the difference between the yield on 10-year and 2-year notes. In other words, the 10’s-30’s spread versus the 10’s-2’s spread. The equation showed that 10’s-30’s is generally 28% of the 10’s-2’s spread (the intercept term is close to zero). As of today, the 10’s-2’s spread is 75 bp, which would imply an expected 10’s-30’s spread of 21 bp. Instead, the actual 10’s-30’s spread is around 40 bp – or more than one full standard error wider than the historic norm. The focus on potential pension fund flows has simply brought the 10’s-30’s spread from an extremely abnormal level to something that is closer to historic norms. If meaningful pension reform is enacted and/or fund managers are otherwise incentivized to switch into long-duration Treasuries, the 10’s-30’s portion of the curve could conceivably invert. But, until that happens, we wouldn’t count on a return visit from Mr. “Long” Bond. morganstanley.com

To: ild who wrote (24586)	2/28/2005 2:44:39 PM
From: mishedlo	Respond to of 116555

Currencies: Reserve Diversification by the Asian Central Banks Stephen L. Jen (London) If the Asian central banks start to diversify out of USD assets in earnest, the USD would be in significant jeopardy. While this is a legitimate risk, I do not think it is a likely scenario, mainly because the Asian central banks would be the biggest losers. I believe that many Asian central banks are likely to be enticed to reduce their exposure to USD assets, while Japan and China — the two largest central banks in Asia and those with the largest official reserves in the world — will likely refrain from significantly reducing their USD exposure. In any case, recent statements by the Bank of Korea highlight one emerging risk: Similar to the problem that OPEC has faced regarding leakage, smaller central banks in Asia may be incentivised to try to diversify before the large central banks do. The mere risk of this scenario could weigh on the USD. The general issue of central bank diversification. This is an important issue, and one that is likely to dominate the thinking of investors in the currency markets. Comments by officials of central banks from the Middle East and Russia powerfully suggest that they have been conducting meaningful diversification of their reserves out of USD. I will not comment on the behaviour of these central banks, focussing instead on the likely behaviour of the Asian central banks. Asian central banks are capable of selling down the dollar, hurting themselves in the process. As of year-end 2004, global reserve holdings totalled US$3.7 trillion. The top seven Asian central banks accounted for close to US$2.3 trillion (about 60% of the world’s total), with Japan and China accounting for some US$1.45 trillion (about 40% of the world’s total). If we assume Asian central banks on average hold the same ratio of their reserves in USD as the rest of the world — i.e., 63.8% — then Asian central banks possess US$1.5 trillion worth of USD assets, mostly held in US Treasuries. Thus, the ability of Asian central banks to sell down the USD and the Treasuries should never be in doubt. A priori, Asian central banks should be unwilling to do anything to trigger a general sell-off in the USD. Even if they start to diversify, it would not be in the interest of the Asian central banks to trigger a generalised sell-off in the USD and USD assets. The Asian central banks would have the most to lose in the event of sharp sell-offs in the USD and USTs. Currency diversification could degenerate into “chasing one’s own tail,” whereby the central bank, in search of a modest gain in one aspect of the reserve management task, suffers major losses from an appreciation in its own currency. Asiacannot diversify when USD/Asia is under pressure. Assuming that the cost of intervention/sterilization is positive (as is the case in South Korea), Asian central banks cannot, in theory, defend USD/Asia and diversify at the same time. Simultaneous USD/Asia intervention and EUR/USD diversification would be tantamount to intervening to support both USD/Asia and EUR/Asia. This would be very inefficient and costly. Thus, notwithstanding the BoK’s announced intentions, the Asian central banks are most likely to diversify, paradoxically, when the USD is not under pressure. Some Asian central banks may have begun to diversify. While some Asian central banks may have begun limiting their weighting in USD assets, Asia as a whole most likely has not commenced large-scale diversification. While there have clearly been large purchases of EUR and GBP by various central banks around the world, one should keep in mind that they and other central banks have likely purchased even more USD in the process. Diversification can be done in two dimensions: across currencies and across asset classes. As reserves grow in Asia, the management of part of these reserves starts to resemble asset management companies rather than official reserves. This means that not all of these reserves need to stay in the sovereigns. The concept of diversification does not necessarily mean, “sell USD.” The US still offers the deepest, most liquid markets for many assets. It would be difficult for the world to significantly reduce its exposure to the only “world” currency. A dilemma emerging. Similar to some OPEC members’ temptation to “cheat,” some members of this informal USD bloc have incentives to start diversifying before others do. There is no guarantee that the small to medium-size central banks will continue to keep their reserves in USD. Tokyo and Beijing are sensitive to the point that they cannot be seen as diversifying out of USD assets, due to their immense exposure to the USD and the Treasury. The problem is that South Korea and Taiwan also know this. This realisation creates a situation where the small and medium-size Asian central banks could try to diversify ahead of the large central banks, undermining the integrity of the de facto dollar zone and possibly triggering a generalised sell-off in the USD.

To: ild who wrote (24586)	2/28/2005 3:49:31 PM
From: mishedlo	Respond to of 116555

Currencies: A Modest Rise in the Risk of China Not Moving in 2005 Stephen L. Jen (London) I have been looking for Beijing to start to dismantle its de facto dollar peg sometime this year. While I still think Beijing will likely move on the RMB later this year, recent developments suggest that the probability of a controlled RMB float this year has declined somewhat. We think investors would still be well advised to have a core short USD/AXJ position, but they should now consider the prospects of the AXJ currencies on their own merits rather than using them as a proxy for a prospective RMB float. Our call on the RMB. There are several facets to our call on the RMB. In principle, Beijing fully supports the view that greater currency flexibility is good for China. I have long reminded investors and policymakers that former People’s Bank of China Governor Dai Xianglong announced, as early as 2001, China’s support of greater currency flexibility. It was not until later, when the USD began to weaken, that foreign policymakers and commentators started to “urge” Beijing to make the RMB more flexible. There should thus be no doubt that China has the same objective as everyone else regarding the RMB. The remaining issues have been the form of the new RMB regime, the timing, and “sequencing.” First, regarding what type of new RMB regime Beijing is likely to adopt, I still firmly believe that the most likely scenario is a move from the current de facto USD peg to a controlled float within a wide corridor centred on a basket reference rate. A one-off large revaluation from the current parity of 8.28 to a lower number is extremely unlikely. So is an outright move to a clean float. Second, in terms of timing, over the past two years, my call has shifted once. From 2003 to November 2004, I called for the RMB to be moved to a controlled float in the second half of 2005. In November 2004, however, I thought that the pressures were mounting for a possible move in 1H05. Third, in terms of “sequencing,” I have always believed that Beijing would first satisfy itself with progress on reforming the banking industry, liberalising capital outflows, and nurturing a more market-based interest rate market. All of these are still prerequisites to any change in the RMB regime, in my view. The marginal changes in my view on the RMB. While I still think we cannot rule out a change in 1H05, I now think that the latter part of 2005 is more probable, and that there is rising risk that Beijing may not do anything regarding the RMB this year. Here are several reasons behind this tweak: · The State Council may have put the whole thing on the back burner for now. In trying to track the status of the RMB discussion in Beijing, one should recognise that while there has been a genuine debate between different groups of policymakers and scholars over the best course of action, the urgings of some technocrats may not reflect the views of the true decision makers in Beijing. In any case, I suspect that in recent months an explicit proposal may have been submitted to the State Council, but the State Council may have decided to put the whole issue on the back burner. Premier Wen Jiabao may have decided that with the economy still struggling to land softly, now may not be the best time to introduce such a major policy shift. In addition, as far as Beijing is concerned, the issue of the RMB may not be linked to only economic considerations. Beijing may be waiting for opportunities to exchange a policy shift on the RMB for “something,” e.g., Taiwan or trade status. Until that something becomes clear and negotiable, the RMB issue will likely remain on the back burner. Third, the general market sentiment on the USD may still be too bearish for Beijing to move. The familiar concern here is that if China allowed a modest appreciation, more speculative capital could be drawn in. Thus, the safer strategy could be to wait until the USD finds better footing. · Inflationary pressures are abating, and the focus on growth is shifting. Outside China, one of the key arguments in favour of a large RMB revaluation or an early float is that “it would be good for China.” The specific argument is that it would help China contain inflationary pressures. One problem with this argument is that inflationary pressures (both CPI and PPI) have abated in recent months. My understanding is that the government in Beijing is less concerned about the headline growth rate or the inflation rate and more concerned about the widening income disparity among regions/provinces. Whether the top policymakers focus on headline growth or growth disparity is very important because, ideologically, currency appreciation helps those who already have money but hurts those who indirectly rely on the export sector to make a living. · Sequencing is key. In recent months, there has also been a greater focus on “sequencing”; i.e., what needs to be done before China can move away from the current RMB regime. There are three broad areas where work can still be done to better prepare China for a new currency regime. First, commercial banks must continue with reforms. Second, capital outflows can be further liberalised. Third, more foreign exchange products need to be introduced.

To: ild who wrote (24586)	2/28/2005 7:01:52 PM
From: mishedlo	Respond to of 116555

Don't Blame Wal-Mart By ROBERT B. REICH Published: February 28, 2005 Berkeley, Calif. — BOWING to intense pressure from neighborhood and labor groups, a real estate developer has just given up plans to include a Wal-Mart store in a mall in Queens, thereby blocking Wal-Mart's plan to open its first store in New York City. In the eyes of Wal-Mart's detractors, the Arkansas-based chain embodies the worst kind of economic exploitation: it pays its 1.2 million American workers an average of only $9.68 an hour, doesn't provide most of them with health insurance, keeps out unions, has a checkered history on labor law and turns main streets into ghost towns by sucking business away from small retailers. But isn't Wal-Mart really being punished for our sins? After all, it's not as if Wal-Mart's founder, Sam Walton, and his successors created the world's largest retailer by putting a gun to our heads and forcing us to shop there. Instead, Wal-Mart has lured customers with low prices. "We expect our suppliers to drive the costs out of the supply chain," a spokeswoman for Wal-Mart said. "It's good for us and good for them." Wal-Mart may have perfected this technique, but you can find it almost everywhere these days. Corporations are in fierce competition to get and keep customers, so they pass the bulk of their cost cuts through to consumers as lower prices. Products are manufactured in China at a fraction of the cost of making them here, and American consumers get great deals. Back-office work, along with computer programming and data crunching, is "offshored" to India, so our dollars go even further. Meanwhile, many of us pressure companies to give us even better bargains. I look on the Internet to find the lowest price I can and buy airline tickets, books, merchandise from just about anywhere with a click of a mouse. Don't you? The fact is, today's economy offers us a Faustian bargain: it can give consumers deals largely because it hammers workers and communities. We can blame big corporations, but we're mostly making this bargain with ourselves. The easier it is for us to get great deals, the stronger the downward pressure on wages and benefits. Last year, the real wages of hourly workers, who make up about 80 percent of the work force, actually dropped for the first time in more than a decade; hourly workers' health and pension benefits are in free fall. The easier it is for us to find better professional services, the harder professionals have to hustle to attract and keep clients. The more efficiently we can summon products from anywhere on the globe, the more stress we put on our own communities. But you and I aren't just consumers. We're also workers and citizens. How do we strike the right balance? To claim that people shouldn't have access to Wal-Mart or to cut-rate airfares or services from India or to Internet shopping, because these somehow reduce their quality of life, is paternalistic tripe. No one is a better judge of what people want than they themselves. The problem is, the choices we make in the market don't fully reflect our values as workers or as citizens. I didn't want our community bookstore in Cambridge, Mass., to close (as it did last fall) yet I still bought lots of books from Amazon.com. In addition, we may not see the larger bargain when our own job or community isn't directly at stake. I don't like what's happening to airline workers, but I still try for the cheapest fare I can get. The only way for the workers or citizens in us to trump the consumers in us is through laws and regulations that make our purchases a social choice as well as a personal one. A requirement that companies with more than 50 employees offer their workers affordable health insurance, for example, might increase slightly the price of their goods and services. My inner consumer won't like that very much, but the worker in me thinks it a fair price to pay. Same with an increase in the minimum wage or a change in labor laws making it easier for employees to organize and negotiate better terms. I wouldn't go so far as to re-regulate the airline industry or hobble free trade with China and India - that would cost me as a consumer far too much - but I'd like the government to offer wage insurance to ease the pain of sudden losses of pay. And I'd support labor standards that make trade agreements a bit more fair. These provisions might end up costing me some money, but the citizen in me thinks they are worth the price. You might think differently, but as a nation we aren't even having this sort of discussion. Instead, our debates about economic change take place between two warring camps: those who want the best consumer deals, and those who want to preserve jobs and communities much as they are. Instead of finding ways to soften the blows, compensate the losers or slow the pace of change - so the consumers in us can enjoy lower prices and better products without wreaking too much damage on us in our role as workers and citizens - we go to battle. I don't know if Wal-Mart will ever make it into New York City. I do know that New Yorkers, like most other Americans, want the great deals that can be had in a rapidly globalizing high-tech economy. Yet the prices on sales tags don't reflect the full prices we have to pay as workers and citizens. A sensible public debate would focus on how to make that total price as low as possible. nytimes.com