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THE DOLLAR VS THE EURO FOR WORLD HEGEMONY
The U.S. economy is dependent on oil being traded in dollars, and the new European single currency, the Euro, seriously threatens that. Iraq switched from dollars to Euro in September of 2000; Iran has been seriously considering it, and has been advocating the Euro for all of OPEC.
This information has been largely suppressed in the U.S. media:
The Real Reasons for the Upcoming War with Iraq: March 2003. Excellent analysis of the U.S. Need to Invade Iraq to not only secure long term oil supplies, but more importantly to secure the hegemony of the dollar as the world’s dominant currency.
Bush’s Deep Reasons for War on Iraq: Oil, PetroDollars, and the OPEC Euro Question. 2/15/03 The title says it all.
Oil, Currency, and Iraq by Cóilín Nunan of Feasta: Very succinct explanation of why the U.S. is so economically dependent on the worlds’ oil supply being traded in dollars. More excellent information on the dollar vs the euro can be found on the Feasta website: www.feasta.org
When Will We Buy Oil in Euros? The Observer UK 2/23/03. The dollar has a challenger to its global oil trade supremacy: the Euro.
Oil, Dollars, Euros, and Dead Iraqis: Information Clearing House 02/03. Clear analysis of why the U.S. is driven to military means to overcome its major economic problems.
North Korea Embraces the Euro: BBC 12/01/02. As long as you’re going to be included in the Axis of Evil, you might as well meet the full criteria.
Dollar’s Decline Starting to Accelerate, Rattling Nerves: Dow Jones Newswire 1/25/03. “All of a sudden, the dollar’s supposedly slow and gradual decline isn’t looking so slow, or gradual.”
Iraq Nets Handsome Profit By Dumping Dollar for Euro: The Observer UK, 2/16/03
The Dollar, Euro, and War In Iraq: How control of the world economy depends on whose currency oil is traded in.
US Dollar Hegemony Has Got To Go: How Control of the world economy depends on whose currency oil is traded in
Why Now? Excellent Article from Australia on the currency of oil
Iran May Switch to Euro for Crude Sale Payments: First Iraq switched to the Euro, and Iran is seriously considering it. Perhaps that explains their mutual inclusion in the Axis of Evil
Iran Export Economics Drive Iran Euro Oil Plan: More on the country which the U.S. says is next for liberation
Iraq Moves to Euro: Crucial to understanding the U.S. aggression against Iraq
Dollar vs Hegemoney: More on the issue of U.S. economic control of world currency
US Dollar Losing Its Position As Asia’s Reserve Currency: 7/12/02 More on U.S. Hegemonic Loss to the Euro.
U.S. Involved in Venezuelan Assassination Plot: Not directly about Iraq, but has good information regarding the U.S. brutal attempts to keep the world oil currency in dollars
http://www.pressurepoint.org/pp_dollar_vs_euro.html
Fundamental vs. Technical
A major debate in financial market analysis is the validity of each of the two major forms of analysis: fundamental and technical. Several studies have concluded that fundamental analysis is more appropriate in predicting trends for the longer periods (one year or more), while technical analysis is more effective for shorter periods (less than ninety days). These studies suggest a combination of these approaches for periods between 3 months and one year. Conversely, more evidence shows that technical analysis of long-term trends helps identify longer-term technical waves and that fundamental factors can trigger short-term developments.
A good example of this is the declining USD/JPY exchange rate in 1999. USA and Japan both lost 16% in the second half of the year, reaching a year low of 101.90. Believers in both fundamental and technical analysis alike could explain the reason for the downward move. Fundamentals attributed it to the continuous capital inflows into Japanese assets, which reflected investors' increased optimism with the recovery of the Japanese, while technical analysts explained the move with the simple argument that the language of the market voiced a clearly downward tone that became clearer with the breach of key technical landmarks (115 yen and 110 yen).
Therefore, in different ways, the technicals and the fundamentals reached the same conclusion. Yet it is in the detail that the true difference is discerned. Fundamental analysts with a technical blind spot could risk missing key market turnarounds after the breach of an important support/resistance level.
On the other hand, a technically inclined analyst with no regard for fundamentals and news releases would have missed the rebound in EUR/USD (triggered by the release of a surprising German business sentiment survey (IFO) in July 19, 1999). Until then, the euro had lost 15% and finally reaching an all-time low of $1.010. Many observers of the market (both fundamentals and technicals) were predicting that the euro would break below $1.00. Technical analysts cited that moving averages, momentum and psychology would lead to further downfall. However, fundamentally-inclined analysts who paid attention to the strong survey would have been able to promptly exit their long dollar positions in favor of the euro. That day, the Euro jumped 200 points against the dollar. It gained an additional 260 points the following day and yet another 150 points in the third day. In just two weeks, EUR/USD soared more than 800 points.
It is obvious that the release of IFO's survey was not the only reason behind the Euros 7% rebound. Over the subsequent weeks, other factors also helped prop the currency, including a broadening improvement in economic fundamentals throughout the Eurozone and increasingly hawkish stance which favored higher interest rates from the European Central Bank. Nonetheless, it is still clear that the release of the IFO survey was the turning point in shifting expectations of the Euro.
Many times is has been said that combining fundamentals with technicals can be counterproductive. Due to the act that they are contrasting types, technical and fundamental analyses are often regarded as mutually exclusive. Yet, a large number of traders often combine these two approaches, sometimes even instinctually. Thus, technically inclined traders do pay attention to central bank meetings and give heed to the latest inflation numbers. Similarly, many fundamental traders are trying to determine the percentage of retracement formations and discern the major and minor levels of support.
There is no a specific formula that can create an optimum approach of combining fundamental and technical analysis in the foreign exchange market. Several software packages claim to be able to calculate such decisions, weighing one approach against another depending on economic, technical and quantitative parameters. Yet these decisions are based on models from previous patterns of inter-market dynamics and past technical and fundamental behavior. t is clear that the FX market is far too dynamic for such pre-formatted frameworks.
It cannot be denied that fundamental and technical factors are an essential factor in determining foreign exchange dynamics. There are, in addition to these two additional factors that are important to understanding short-term movements in the market: expectations and sentiment. Although they may sound similar, they are fairly distinct. Expectations are generated prior to the release of economic statistics and financial data. It has been shown that monitoring only the figures released does not suffice in grasping the currency's future course. For example, if the US GDP came out at 7.0% from 5% in the previous quarter, then the dollar may not necessarily move as you would expect it to. If market forecasts had expected an 8% growth, then the 7.0% reading might come as a disappointment. This could cause a very different market reaction from the one that was expected there was no awareness of the forecast.
Nevertheless, market sentiment can supercede expectations. That is the prevailing market attitude in relation to an exchange rate; it can be a result of the overall economic assessment towards the country in question, general market emphasis, or several other factors. Using the previous example of the US GDP, even if the resulting figure of 7.0% undershot forecasts by a full percentage point, markets could possibly show little or no reaction. One possible reason for this is that sentiment could be dollar positive regardless of the actual and forecasted figures. This could be due to poor fundamentals in the counter currency (Euro, Yen or Sterling) or solid US asset markets.
There is a term that is commonly interchanged with "sentiment," and that is "psychology." In first two months of 2000, the Euro dealt with fierce selling pressure against the Dollar, even though it was persistently improving fundamentals in the Eurozone. This may be due to the fact that market psychology favored US dollar assets due to continuous signs of non-inflationary growth, and sentiment that further increases in US interest rates would work in the advantage of US yield differentials without ruining the economic expansion.
http://www.cmcgroupplc.com/us/forex/home.jsp?OVRAW=Currency%2520Charts&OVKEY=chart%2520currency&...
What is the date of that article? Thanks.
Extracting Market Expectations on the Duration of the Zero Interest Rate Policy from Japan's Bond Prices
http://www.boj.or.jp/en/ronbun/03/kwp03e02.htm
http://www.fpcj.jp/e/shiryo/jb/0032.html
http://www.atimes.com/editor/BE24Ba01.html
http://news.bbc.co.uk/1/hi/business/1228152.stm
http://www.jei.org/Archive/JEIR00/0028w1.html
http://www.jei.org/index.shtml#hometop
The zero interest rate policy (ZIRP) is a macroeconomics scheme devised by economist Paul Krugman for economies exhibiting slow growth with a very low interest rate, such as contemporary Japan. Under ZIRP, the central bank maintains a 0% nominal interest rate, and then maintains inflation of the currency to make the value of otherwise stable investments, such as real estate, rise over time. It is effectively a way of imposing a negative interest rate, which is otherwise impossible to do.
For instance, with a 0% interest rate and 4% inflation rate, a house or commercial property will appreciate in value by 4% a year. This means that the return on the investment is calculated as if the interest rate is actually -4%.
The effect of a ZIRP policy is to encourage investment throughout the economy by making capital purchases more financially attractive.
Macroeconomics is the study of the entire economy in terms of the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. Macroeconomics can be used to analyse how best to influence policy goals such as economic growth, price stability, full employment and the attainment of a sustainable balance of payments.
Until the 1930s most economic analysis concentrated on individual firms and industries. With the Great Depression of the 1930s, however, and the development of the concept of national income and product statistics, the field of macroeconomics began to expand. Particularly influential were the ideas of John Maynard Keynes, who used the concept of aggregate demand to explain fluctuations in output and unemployment. Keynesian economics is based on his ideas.
One of the great challenges of recent economics has been a struggle to reconcile macroeconomic and microeconomic models.
Theorists such as Robert Lucas Jr suggested (in the 1970s) that at least some traditional Keynesian macroeconomic models were questionable as they were not derived from assumptions about individual behavior.
Today the main schools of macroeconomic thought are as follows:
Keynesian economics, which focuses on aggregate demand to explain levels of unemployment and the business cycle. That is, business cycle fluctuations should be reduced through fiscal policy (the government spends more or less depending on the situation).
Monetarism, which holds that inflation is a monetary phenomenon. That is, it does not wish to combat inflation or deflation by means of demand management as in Keynesian economics, but by means of monetary policy (essentially altering the interest rate).
New classical economics, which emphasises the idea of rational expectations. Their original theoretical impetus was the charge that Keynesian economics lacks microeconomic foundations -- i.e. its assertions are not founded in basic economic theory. This school emerged during the 1970s.
New Keynesian economics, which developed partly in response to new classical economics. It strives to provide microeconomic foundations to Keynesian economics by showing how imperfect markets can justify demand management.
Supply-side economics, which deliniates quite clearly on the role of monetary policy and fiscal policy. The focus for monetary policy should be purely on the price of money as determined by the supply of money and the demand for money. It advocates a monetary policy that directly targets the value of money. Typically the value of money is measured by reference to gold or some other reference. The focus of fiscal policy is to raise revenue for worthy government investments with a clear recognition of the impact that taxation has on domestic trade.
A new school of economic thought is emerging called Freenomics. It uses some of the theories put forth by Krugman but because of the vast amount of information that is being synthesized in bringing this view to the macroeconomic model, it may be some time before a book on the subject is fully released. The basis of Freenomics is both a zero interest rate policy and global debt free financial system which operates under one singular currency.
Paul Krugman (born 1953) is an American economist. He is probably best-known to the public as an outspoken and formidable critic of the economic policies of the administration of George W. Bush. Unlike many economic pundits, he is regarded as a respected economist by his peers. Krugman has written hundreds of papers and eighteen books - some of them academic, and some of them written for the layman. His International Economics: Theory and Policy is a standard textbook on international economics.
Krugman was born and grew up on Long Island, and majored in economics as an undergraduate at Yale. He obtained a Ph.D. from MIT in 1977 and taught at Yale, MIT and Stanford University before joining the faculty of Princeton University, where he has been since 1996. From 1982 to 1983, he spent a year working at the Reagan White House as a member of the Council of Economic Advisers.
When Bill Clinton came into office in 1992, it was expected that Krugman would be given a leading post, but he was passed over for various reasons. However, it allowed him to turn to writing journalism for wider audiences, first for Fortune and Slate, later for The Harvard Business Review, Foreign Policy, The Economist, Harper's, and Washington Monthly. In his own words, he became adept at "new kind of writing ... essays for non-economists that were clear, effective, and entertaining."
Since January, 2000 he has contributed a twice-weekly column to the Opinion/Editorial page of the New York Times which has made him in the words of the Washington Monthly "the most important political columnist in America.... he is almost alone in analyzing the most important story in politics in recent years — the seamless melding of corporate, class, and political party interests at which the Bush administration excels."
In September, 2003, Krugman published a collection of his columns under the title, The Great Unravelling. It was a scathing attack on the Bush's administration's economic and foreign policies. The book was an immediate bestseller.
Krugman's high profile has turned him into a target of unrelenting scorn, verbal abuse, and ad hominem attacks by his detractors, as well as praise from his many fans.
In the 1990's Paul Krugman's focus was on what can be described as policy economics, which he attempted to explain to the general audience in such works as "Pedaling Prosperity" and columns attacking what he described as "policy entrepreneurs" who were focused single mindedly on particular solutions which they proposed as solving every conceivable crisis.
Krugman was the main architect of the zero interest rate policy. He can be reached through http://www.wws.princeton.edu/~pkrugman/
Freenomics is the invention of Hungarian born philosopher Gabor Sandor Acs and aims to present to the world an advanced system of finance that benefits the greater good. It is coined from the words "free" and "economics" and seeks to separate politics and religion from the subject and science of economics.
An interest rate is the 'rental' price of money. When a resource is borrowed, the borrower pays the lender for the use of the resource. The interest rate is the price paid for the use of money for a period of time. When money is loaned the lender defers consumption (or use of the money) for a specific period of time. The lender does this in exchange for an increase in consumption. The increase in consumption expected is the real interest rate. The increase in consumption, however, is diluted by the effect of inflation. Thus the actual rate charged (known as the nominal rate) has to take inflation into account. Quite simply the nominal rate is:
rn = rr + i
where:
rn = nominal interest rate
rr = real interest rate
i = projected inflation
Other approximations for the nominal interest rate exist.
rn = rr + i + d + mrp + lp
where
d = default premium (likelihood of default by the borrower)
mrp = maturity risk premium (risk factor for length of borrowing period)
lp = liquidity premium
Fisher Theory of Interest Rates
Irving Fisher proposed a better approximation of the relationship between nominal interest rate, inflation and real interest rate.
(1 + rn) = (1 + i)(1 + rr)
For example: assume the real rate desired is 2% but inflation is running at 5%. Then the lender will charge:
(1 + .05)(1 + .02) = 7.1%
The resource called money is an invention of the human mind. It does not exist except when human minds agree to its existence. What props up one money system over another are numerous political and religious factors too lengthy to elaborate here.
Suffice it to say that all currencies are now fiat currencies. Their values are totally dependant on three key factors: Perception, Confidence and Power. In Freenomics this is called the PCP Triangle of Economics. The three are interlinked and add up to what economics should really be. A Science.
Today economics has not been codified into an exact science, otherwise most economists and analysts would be right more than what they often refer to as revisionist economics as a reason for their failures at predicting the future of any single economy let alone the macroeconomic interactions of nations which has resulted in todays global finance system.
When perception falters, the power and confidence of that currency diminishes. When the power of a currency to be exchangable for goods, services and other "value items" produced by the economy is diminished, so follows confidence and perception. The three factors are intertwined such that one cannot change one without influencing or effecting the other two.
Using the PCP Triangle one can predict the collapse of the U.S. Dollar as is occuring at this point in history. The factors that influence the perception, the power and the confidence in the dollar are legion. These will be dealt with fully in the treatise on the subject of Freenomics.
Freenomics: The Modern Science of Free Economics will seek to codify the subject of economics. It will be a lengthy book worth reading and sharing.
In economics, inflation is the rise in the general level of prices. This is equivalent to a fall in the value or purchasing power of money. It is the opposite of deflation. In Freenomics there is no inflation or deflation. They are both eliminated.
Inflation is measured by observing the changes in prices of goods in the economy using econometric techniques. The rises in prices of the various goods are combined to give a price index that reflects the change in prices of these many goods, where the inflation rate is the rate of increase in this index. There is no single true measure of inflation, because the value of inflation will depend on the weight given to each good in the index. Examples of common measures of inflation include:
consumer price indexes which measure the price of a selection of goods purchased by a "typical consumer". In many industrial nations, annualised percentage changes in these indexes are the most commonly reported inflation figure.
producer price indexes which measure the price of a selection of inputs purchased by a "typical firm".
wholesale price indexes which measure the change in price of a selection of goods at wholesale (i.e., typically prior to sales taxes).
commodity price indexes which measure the change in price of a selection of commodities. In the case of the gold standard the sole commodity used was gold. While under the USA bimetallic standard the index included both gold and silver.
GDP deflator which is used to adjust measures of gross domestic product for inflation.
The role of inflation in the economy
A great deal of economic literature concerns the question of what causes inflation and what effects it has. A small amount of inflation is often viewed as having a positive effect on the economy. One reason for this is that it is difficult to renegotiate some prices, and particularly wages, downwards, so that with generally increasing prices it is easier for relative prices to adjust. Inflation may also have negative effects on the economy:
Increasing uncertainty may discourage investment and saving.
Redistribution
It will redistribute income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation.
Similarly it will redistribute wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax.
International trade: If the rate of inflation is higher than that abroad, a fixed exchange rate will be undermined through a weakening balance of trade.
Shoe leather costs: Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank.)
Menu costs: Firms must change their prices more frequently, which imposes costs, for example with restaurants having to reprint menus.
Some economists see moderate inflation as a benefit, and so there are a variety of fiscal policy arguments which favor moderate inflation. Central banks can affect inflation to a significant extent through setting the prime rate of lending and through other operations. This is due to the fact that most money in industrialised economies is based on debt and so controlling debt is thought to control the amount of money existing and so influence inflation. A government may find some level of inflation to be desirable, particularly in order to raise funds.
Causes of inflation
Inflation may be caused by an increase in the quantity of money in circulation. This has been seen most graphically when governments have financed spending in a crisis by printing money excessively, often leading to hyperinflation where prices rise at extremely high rates. Another cause can be a rapid decline in the demand for money as happened in Europe during the black plague.
The money supply is also thought to play a role in determining levels of more moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics by contrast typically emphasise the role of aggregate demand in the economy rather than the money supply in determining inflation.
A fundamental concept in such Keynesian analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggested that price stability was a trade off against employment. Therefore some level of inflation could be considered desirable in order to minimize unemployment. The Philips curve model described the US experience well in the 1960s, but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.
Sadly, Keynes was wrong. Inflation ultimately results in revolt if not revolution so its long term effects cannot be considered anything close to good. It is Keynesian economics which has landed the United States and the rest of the world into a global morass of interest bearing debt. Any economist who says there are benefits to inflation is either very short sighted and ignorant of thousands of years of human history, or is getting paid to tout inflation as a good thing.
Another Keynesian concept is the natural gross domestic product, a level of GDP where the economy is at its optimal level of production. If GDP exceeds its natural level, inflation will accelerate as suppliers increase their prices. If GDP falls below its natural level, inflation will decelerate as suppliers attempt to fill excess capacity.
GDP is a fallacy. There can be no optimal level of production unless that level is determined by political and or religious factors. The religion of money is as corrupt as the religion of politics. The three have been intertwined for so long that removing them as the viruses that they are on the subject of economics is liable to make the systems in use crash. Thus it becomes not only a delicate subject, it becomes a subject which when codified will certainly raise a stir among those who seek to maintain their artificial means of controlling money and the global economy. The only problem with that attempt is that those in such positions are far outnumbered by those that are not.
Stopping inflation
There are a number of methods which have been suggested to stop inflation. One method often attempted is simply instituting wage and price controls, which were tried in the United States in the early 1970s. However, most economists regard price controls as counterproductive in that they tend to distort the functioning of the economy. Monetarists emphasize increasing interest rates in the hope of reducing the money supply. Keynesians emphasize reducing demand, often through fiscal policy, using increased taxation or reduced government spending to reduce demand. Supply Siders advocate managing the pool of money in such a way as to fix the exchange rate between the currency and some reference currency such as gold. A freenomicist would look at all these failed economic theories, policies and models and throw them all out as rubric influenced by the political agendas during the period they were invented. If money is an invention of the human mind, then all past forms of economic theory are just that, theories. Science has no place for theories. Either something works or it doesn't. The laws of free economics can be boiled down to a science. Freenomics may become the only science of economics because like love and sex, the more opinions written about the subject, the less real knowledge and wisdom can be found.
An economic science cannot be built on theories. It must be built on true knowledge of the laws of economics. To understand Freenomics then, one would have to know the basic laws of economics much like any other scientist would want to know the basic laws of gravity. Laws made by man can be broken. Natural laws of economics cannot be broken without consequence, just as you cannot throw the baby out with the bath water and expect the baby to land safely on the ground. The law of gravity cannot be violated without more exact tools developed by science.
Types of inflation:
Demand pull inflation
Cost push inflation
Inflation induced by adaptive expectations, often termed the "wage-price spiral"
Historically, inflation meant an increase in the money supply, which was the cause of price increases. Some economists still prefer this meaning of the term, rather than to mean the price increases themselves.
A good basic start in understanding Freenomics is to learn the meanings of the following words:
Hyperinflation
Stagflation
Central bank
Macroeconomics
Economics
Price revolution
Rule of 72- a rule of thumb for calculating the period for inflation to halve the purchasing value of a fixed amount.
Deflation
Political economy is a social science closely related to the social science of economics. Political economy is distinct from economics in that it is more interdisciplinary in nature, drawing upon fields such as law and political science, and often has a broader scope.
There are several advantages inherent in the broader scope offered by studying political economy. First, by taking full advantage of the best techniques from economics and political science, resulting conclusions can be more indepth and complete. Second, focusing in on only on one subject disregards valuable insights from the other areas which may lead to conclusions that are biased, or incomplete.
The scope of political economy
Political economy is centrally focused on the development of the polity. It pays particular attention to whether the polity is running a surplus or a deficit, since in the view of political economy, any deficit must be met by selling assets, such as gold or other capital, to other polities - or by some form of borrowing or externalization.
Political economy, then, studies the mechanism of human activity in organizing material, and the mechanism of distributing the surplus or deficit that is the result of that activity. Note the difference between this paradigm and that of economics which sees human wants as unlimited, resources as generically scarce, historical context as not particularly important, and income distribution issues as less important than efficiency and growth. Whereas economists try to use positive economic techniques to reign-in (some would say hide) their normative value judgements, political economists tend to be unabashfully normative.
Current uses of the term political economy
Almost all dictionaries describe political economy as economics. As we saw from above this is somewhat inaccurate as there are subtle distinctions to be made between these two fields. There are two reasons for the similiarity: first, there are few, if any, questions or problems that would be exclusively in the domain of one or the other. Second, political economy and economics used to be one in the same, with the 'political' part largly splitting off to develop into the field of political science. The next section on the history of political economy will explain why this split occured, the impedus behind it, and a general timeline of political economy from its beginning to present.
The history of political economy
Political economy first began as a field of study within the social sciences withing Adam Smith's book Inquiry into the Nature and Causes of the Wealth of Nations, (often simply called The Wealth of Nations) (1776).
Timeline of political economy
Central concepts of political economy
(Much of this entire catagory can go into economics if it isn't already there, anything that political economy deals with a great deal should stay.)
Political economy studies the means of production, specifically capital, and how this manifests itself in economic activity. Where as economics focuses on price, and sees production and consumption as "effects" on price - political economy sees economics as a manifestation of underlying reality which is effected by policy and law. The division into "value in use" and "value in exchange" makes a clear distinction between what would now be called "value" and "price" or "capital value" and "commodity value", in constrast to the denial of intrinsic values separate from prices in, for example, neoclassical economics.
In political economy labor is used to mean human activity which produces change, and capital the means by which the change from that labor is made greater. The results of labor are commodities which are exchanged, and consumed, which leads to the problem of disposal of the results of consumption.
Private exchange occurs in the market, and is based on a legal framework of possession and title, this is also called the private sector. Government exchange occurs through politics, and influences market decisions through policy. The government as a player in the market economy is called the public sector.
Political economy in its normative form focuses on the necessities of production, exchange, consumption and disposal, referred to as infrastructure. In its descriptive form it focuses on the classification and detailing of the workings of production, for example as in David Ricardo in [On the Principles of Political Economy]
Political economy, because it is concerned with a view of underlying reality is often required to be multi-disciplinary in its approach.
Production
In political economy production refers to the use of labor, with the aid of capital, to create a determinate and recognizable thing which has use, or utility (see Utilitarianism). Studying the relationship of production is crucial to political economy, since economics only recognizes general demand, while production is often bottlenecked by specific resources, and political activity is often centered around securing of resources perceived to be creating a bottleneck.
Political economy views production as the central activity of a political economy, and views the labor available as the ultimate bottleneck for state activity. The polity must supply its needs from its available stock of labor, and thus must have sufficient capital available to allow that labor to be sufficient. Thus the basic equation of political economy may be phrased as:
Labor involves not only time in the abstract sense, but the realities of human beings, both as social and economic beings. The basic formula of political economy was described by Adam Smith in his "Wealth of Nations":
capital(labor) - investment - consumption = surplus/deficit
Capital is the function, into which is put labor. Investment is the amount spent developing the stock of capital, and consumption is the use of utility. A polity which has a surplus is then able to buy assets or capital from abroad, or increase investment or consumption. A polity where investment and consumption taken together are greater than the production will run a deficit, and must borrow or sell assets to make up the difference.
The study of production then focuses on how capital interacts with labor, in the broad, rather than narrow sense. This is because labor must, to make use of capital, have the necessary skills and social infrastructure. In Marxian terms, social infrastructure is referred to as consciousness and societies with sufficient social infrastructure to produce what they consume and control their own capital are said to have the "objective" basis for production.
Capital
Capital may be said to be any tool which increases the ability of labor to organize material into usable form. Physical Capital refers to tangible objects which, when employed, allow greater production. Intellectual Capital refers to concepts, ideas, designs, theories and information which allows an individual act with greater effectiveness. Physical capital implies an intellectual capital required to use it. Human capital can be described as the readiness of labor to use capital, and includes education, social norms, ethical understanding, networks of relationship and communication, health and general well being.
Capital can be for postive production, but, in political economic terms, weapons are also capital. States pursue political economy, in no small degree, to be able to produce the capital of projecting power and force. Often the projection of force is to acquire resources required for production, or the opening of labor to be utilized in production, or to open markets for the results of national production.
Transportation
Labor and resources need to be able to get to capital, and commodities need to be moved to where they can be exchanged and consumed. This creates the need for transportation - of people, things and information.
The need to move labor and resources to within range of capital is seen in the creation of transportation grids, such as trains and roads. The need to coordinate production is seen in the creation of communication grids.
Exchange
From the view of political economy, exchange is the process where the producers of commodity or investment exchange with consumers. Each producer is then a consumer, and each consumer is a producer. The market provides a mechanism for exchange, and money provides a medium of exchange. Consequently, the dynamics of monetary exchange are a central focus of much of political economy.
The infrastructure of exchange determines the possible range of market possibilities. Political economy views the long term of economic activity as the successive creation of political capital sufficient to manage the range of monetary exchange required by the society. In simple terms, the money is a commodity which a society produces, and in order to function, the money it produces must be capable of sustaining the market which the society uses. Adam Smith enumerates early in Wealth of Nations a list of requirements for the functioning of a market, which include stability of exchange and expected rates of profit in various enterprises.
The mechanisms of exchange are generally studied through a framework rooted in economics.
Consumption
Consumption is the return of material organized by production back to a state of being unusable. Consumption is based on the utility of that which was consumed, and is the goal or purpose that people seek to attain.
Disposal
Disposal is the least glamorous area of political economics, but in many respects the most vital. People produce waste. Waste, if allowed to accumulate, creates disease and other undesirable effects. Providing the infrastructure of removing that waste, or neutralizing its harmful effects, is a large fraction of the history of urban development. As Fiorella LaGuardia famously remarked "there is no Republican or Democratic way to collect the trash on time".
Sewage systems, garbage collection, clean air laws and recycling are all results of the need to dispose of after effects, and take up a significant fraction of the political life of most localities. On the scale of political economy, wastes produced often require more space or expertise than can be managed locally.
Disciplines which relate to political economy
Because political economy is not a unified discipline, there are a variety of studies that use the term which have overlapping subject mater, but radically different viewpoints.
Sociology is the study of the effects of involvment in society on individuals as members groups, and how this changes their ability to function. Many sociologists begin from a framework of production determining relationship drawn from Karl Marx.
Anthropology often studies political economy by studying the relationship between the world capitalist system and local cultures.
Psychology is frequently the fulcrum around which political economy centers, in that it deals with decision making, not as being a black box whose effects are seen only in price decisions, but as being a source of study, and therefore the assumptions in a model of political economy.
History since it documents change over time, is often used as a means of arguing in political economy, and often historical works have a framework of political economy which they assume or argue as the basis for the narrative structure.
Economics, because it studies activity and price relationships and the effects of scarcity, grew out of political economy. It is often used in political economy to argue policy effects and study the results of actions, and it is often in opposition to political economy, in that many, if not most, practicing economists see political economy as being a hinderence to the operation of economic forces. From the point of view of political economy, economics is a branch of the entire study, and economics has, at its basis, a theory of political economy which should be open to examination.
Law since it concerns the creation of policy, or the mediation of policy ends through political acts which have specific individual results, is seen, in political economy, as both political capital and social infrastructure, on one hand - and as the result of the sociology of a society on the other.
Ecology is often involved in political economy, because human activity is one of the single largest effects on the environment, and because it is the suitability of the environment for human beings which is one of the central concerns of most human beings. The ecological effects of economic activity on the environment have spured the creation of a great deal of research studying means of changing the incentives balance of the market economy. This work is particularly controversial in its interaction with economics, since it questions the fundamental econometric assumptions of market economics and their basic validity. See the commons.
General paradigms of political economy
Political economy has the paradigmatic assumptions of its practioners in greater visibility than many other fields. The two general areas of paradigmatic controversy, not to say endless and rigid ideological trench warfare in many cases, center on two major questions: the paradigm of distribution, and the paradigm of production. At the extremes they are related, however, there are a vast number of cases of individuals accepting almost diametrically opposite views on these two paradigms in the same context.
Paradigms of distribution
Societies produce more than isolated individuals, and labor with the aid of capital produces more than labor alone. Societies also generate more waste, and capital makes demands for investment and organization. The first can be referred to as the social surplus and capital surplus respectively, and the second social costs and capital requirements. One of the most important social costs is war. Indeed the difference between political economy and economics is that, in economics, war is a temporarily alteration in price variation, the old joke being that "World War III, should it come, will be noted in two sentences in the Wall Street Journal, with an article inside on its effect on soybean futures."
The paradigms of political economy may be classified based on their view of distributing the social costs and benefits, and the capital costs and benefits.
Libertarianism: Libertarianism denies that there is any significant difference between capital surplus and social surplus: all improvments to productivity are capital surplus and belong to the individual. Libertarianism contends that by paying for inputs, an individual has paid for the social cost of their activity, and that to avoid disutility, individuals will rationally trade effects of economic activity that are adverse. Libertarians, therefore, generally believe in an absolute standard of value, generally the gold standard. Libertarians point to John Locke, Thomas Jefferson, Adam Smith and Ralph Waldo Emerson as antecedants, and argue that they are merely continuing "classical liberalism". In the libertarian framework, since there is no social surplus, any attempt to distribute is, by definition "socialism" - that is, that economics is separate from the political sphere. (See laissez-faire)
Libertarianism's first major school of thought was the Austrian School of economists, and found expression in laissez-faire economics. Libertarians may be said to be economic and social extreme individualists. Important, or at least widely cited, thinkers in Libertarian thought include Ayn Rand, Hayek and Ludwig_von_Mises
Liberalism: Liberalism believes that capital surplus should acrue to the individual, but that social surplus and cost should be distributed as widely as feasible within the context of maintaining the individuals expectation to the surplus of their own efforts. Liberals therefore believe in state intervention in political economy to measure and distribute social costs and benefits. Many thinkers are, therefore, held in common between libertarianism and liberalism - since when the social surplus is perceived of as being low, or in particular areas, there is nothing to distribute. Liberalism traces its roots to Machiavelli and his views on the importance of state power in growth, and continues forward through humanism. Liberals also agree with Conservatives about the need to protect against the ill effects of social disorganization, even if the manner of doing so differs.
Liberalism sees the expansion of the rights of the individual in the philosophy of Rousseau and Jefferson as being the entitlement to a certain reasonable standard of life necessary to participate in society. From the pragmatic viewpoint, the necessity of human capital sufficient to engage in the full range of production.
Liberalism has been propounded by such thinkers as John Dewey, John Rawls, Isaiah Berlin economists such as John Maynard Keynes and educators such as Mortimer Adler.
Conservatism:Conservatism belives that capital surplus acrues to the individual, and that there is little or no social surplus, but that there are significant social costs, which must be distributed across the society. Examples of this include military service, standards of personal morality and charity.
Conservative thought became established in English philosophy with the work of Thomas Hobbes, but became a political doctrine with Edmund Burke. Conservatism in the modern period looks to libertarian economic thinkers, but toward the absolute need for social structure enforced by normative institutions such as religion and nationalism. Prominent modern schools of Conservative include the work of Leo Strauss in the USA
Socialism: Socialism believes that the ratio of capital surplus to social surplus is very low, that most of the surplus involved in human production is predictated on being a member of society, and therefore social control of the means of production, and the profits, should be distributed first to provide benefits to all members of a society.
Socialism evolved from critiques of human misery in the late 18th century such as the political philosopher Fourier. In the view of socialists, the market could never efficiently distribute the social surplus, and private ownership merely substituted one form of tyranny for another.
Communism: Communism believes that there is no difference betwen capital surplus and social surplus, but, in the reverse of the libertarian viewpoint, it believes that all surplus is socially created. The most prominent communist thinker was Karl Marx, who called himself a "scientific socialist". There is a long tradition of using the word "socialism" as a synonym for "communism".
Paradigms of production
Work is done, however, the ability of some individuals to create capital or perform work with a far greater impact on society than others creates the question of what basis production should be measured.
Individualism: Individualist paradigms state that the single person, with his or her will, desires and decisions is the basis of production, and that only individual accomplishment and happiness matter. Society is an instrument in so far as it produces individual happiness or utility.
Communitarianism:Communitarian paradigms state that it is the action of a group, with particular exceptional individuals, which produces. Communitarian thinkers work in concepts such as inter-subjectivity and the dynamics of group production. The individual, within a community, is considered to be the basic unit.
Collectivism: Collectivist paradigms state that it is impossible to show with any degree of precision what the contribution of an individual is, and all artifacts and accomplishments must be regarded as the result of a group effort.
These two questions, generally move in this same direction, however this is far from universally the case. It is entirely possible, for example, to take the stance of being an individualist, and then conclude that individuals will be happiest in a communist society.
The market
One of the central conflicts in political economy is, of course, the role and functioning of the market economy in society. It is here where the broad range of paradigmatic assumptions collide, and on particular issues, individuals and groups with widely differing views will find common intellectual and practical political cause. In the political world, the fulcrum is on the ownership of capital surplus and production.
In the context of political economy, capitalism takes on a very broad meaning: the focus of the state on the maintaining and creating of capital and the means of its utilization. Many paradigms use the word in a much narrower context to mean private ownership and the self-justifying results of market operation, and deny that any other use of the word is appropriate, see Libertarianism. However, the vast majority of governing and major opposition parties in the industrialized world see the maintaining of capital capability as an area for legitimate state interest, and therefore maintain that government intervention the market to prevent its disintegration, and even to promote certain aspects of its advancement is a proper use of state power.
Socialism, viewed as a system of political economy, states that the forms of production on which labor is dependent to sell to should be maintained, or overseen, by political power, and generally state power. This brings socialism into conflict with many liberal ideologies, which believe that production for capital profit is best left in private hands. See Labour Party for further details of hybrids of market-socialism.
Communism sees the necessity control of all surplus generating activity. Communist parties have existed in most industrialized nations, and communist revolutionary movements are still seen in some nations today. Within the paradigm of communism there are a host of particular theories. Not all Marxian theories are communist, and not all communists are necessarily Marxian in their orientation.
A good place to start a study on the more modern history of economics and various schools of thought is at this link:
http://cepa.newschool.edu/het/
Top-Down: "Sterilized" Versus "Unsterilized" Intervention in the Currency Market. The Result is the Same Under ZIRP
The BOJ's surprise move appears to be a change of tact, aimed at several monetary policy goals.
But under a ZIRP (zero interest rate policy) regime, the monetary base and short-term government bills are almost complete substitutes. This means that; a) "unsterilized" currency market intervention has essentially the same impact as "sterilized" intervention on the exchange rate, and b) that the increased current account balances have per se have no economic effect, as they play no part in the creation of credit.
The bottom line is that foreign exchange traders are correctly assuming that despite the new tactics, the BOJ is effectively giving them a green light to trade the yen higher.
Bottom-Up: What the Foreigners Giveth They Can Also Taketh Away
Aggressive buying by foreign investors has provided the only buying demand for Japanese equities since April, leaving Japanese stock prices very susceptible to a change in perceptions by foreign investors.
Essentially, "what the foreigners giveth, they can also taketh away". This plus the assumption of continued yen appreciation means that the export-related, international blue-chips will continue to underperform the Topix on a relative basis until the top in the yen is confirmed.
Conversely, Japan's small cap stocks continue to mark new rebound highs, ostensibly because of still active individual investors (day traders) buying TSE 2 and JASDAQ stocks not subject to "daiko henjyo" by the domestic corporate pension funds, and the shifting relative value perceptions of foreign investors.
In addition, mining stocks have been outperforming the Topix as a whole, reflecting; a) sharp gains in the underlying global precious metals and industrial metals markets, and b) sharp gains in the mining and non-ferrous sectors in the US market. Ironically, the best performing stocks in the sector have the weakest balance sheets, in keeping one pattern of this rally, where the buying tide is especially favorable for the leakier boats.
Top-Down: "Sterilized" Versus "Unsterilized" Intervention in the Currency Market. The Result is the Same Under ZIRP
After using over JPY13.5 trillion in an effort to keep the yen from appreciating, the BOJ apparently has changed tactics. On Friday of last week, it made a surprise and unusual decision at its Policy Board meeting to ease monetary policy further by raising the upper limit on the target of current-account deposits by¥2 trillion to ¥32 trillion yen, for a new range of ¥27-¥32 trillion yen. This is the first easing of its policy in nearly five months.
What is the BOJ up to? Just weeks ago, Governor Fukui was denying there was a need for such steps. The stock market evidently liked what they saw in the BOJ policy move, while the Yen shot up to the ¥108/US$ level, or well above the ¥115/US$ level the BOJ had fought so hard to maintain with massive currency market interventions to date.
The BOJ action appears aimed at several policy goals:
They want to offset the deflationary impact of a stronger yen, as a strong yen does work to reduce GDP growth as well as corporate profit growth.
They hope they can keep a lid on the spike in long-term bond rates, and to show the markets they are as committed as ever to maintaining their quantitative easing measures.
Since the G7 pronouncements have apparently made it more politically difficult to aggressively intervene, they appear to be trying a different tactic, as inevitably the stronger yen will illicit howls of protest from corporations and their supporters in the government.
But economists have long maintained that currency market intervention, particularly "sterilized" intervention, does not work if the economic fundamentals do not support it. Moreover, there is essentially no difference between "sterilized" and "unsterilized" intervention under a ZIRP (zero interest rate policy) regime. The level of the yen-both under sterilized or unsterilized intervention-is only relevant to the extent the level of the yen is a function of interest rates, but the monetary base (defined as banknotes and coins in circulation plus current account balances at the BOJ) and short-term government bills are almost complete substitutes under ZIRP. Thus it makes no difference whether the intervention is sterilized or not.
Ergo, foreign exchange traders correctly assumed that by changing tactics, the BOJ was giving them a green light to trade the yen higher. This makes us even more convinced that the Japanese yen is heading through ¥100/US$ and could very well challenge its prior high of ¥79/US$.
By the same token, the amount of clearing balances at the BOJ have no economic effect, as they play no part in the creation of credit. The BOJ is just pushing harder on the same string they have been pushing on all along, given the current liquidity trap.
There may be several trillions of yen sloshing around in the BOJ's current accounts, but precious little will find its way into the real economy unless the banking sector can resume its traditional role of being a money multiplier for the economy. As the graph at right shows, the money multiplier continues to shrink. Here, news that Resona Bank is aggressively moving to pare down its NPLs with a massive ¥1.79 trillion write-down is encouraging news, but the rest of the banking sector needs to follow suit. Consequently, the Bank of Japan has actually done little other than stand on the sidelines and give the stock market a good "gambatte" cheer.
Bottom-Up: What the Foreigners Giveth They Can Also Taketh Away
Foreign investors have yet again given Japanese equities a very welcome rally. Since April of this year, foreign investors have been net buyers of Japanese equities by ¥5.3 trillion, according to Tokyo stock exchange statistics (MOF statistics show ¥6.9 trillion of net buying).
At the same time, they have been net sellers of Japanese government and corporate bonds by some ¥3.22 trillion, indicating that some yen asset switching from bonds to equities has taken place.
But foreign investors have been virtually alone in their bullish stance on Japanese equities. During the same period (April- September) domestic investors have been net sellers of Japanese equity by ¥5.2 trillion, including ¥2.4 of net sells by the trust banks, ¥820 billion by individuals, and even some net selling by the brokers on their prop accounts.
When foreign investors first became net buyers of Japanese equities in April, there was a strong feeling that Japanese stocks had significantly lagged the global rebound in equities. The last couple of weeks however have seen a subtle change in aggregate net buying by foreign investors. During the third week of September, foreign investors turned net sellers of Japanese equities for the first time in 24 weeks, and the Nikkei 225 promptly corrected 7.4% from a high of 11,033 on 19 September.
Time for Increased Stock and Sector Selectivity
Because the yen could well continue appreciating despite the BOJ's efforts, Japan's export-oriented, international blue chips will continue to underperform on a relative basis. Thus such stocks should be avoided until the yen's appreciation peaks.
Conversely, both the Topix 2 and the JASDAQ have outperformed the larger indices during this recovery, and should continue doing so. It is in the small stocks where individual investor buying can have the most favorable impact, as there is less volatility from cross-holding unwinding by domestic institutions on the one hand, and possible foreign investor selling on the other.
In addition, Japanese stocks often take a hint from trading trends in the US market. During the past three months, the best performing sectors in the Dow Jones US indices have been minin and non-ferrous metals, as investors have switched gears and are now trying to discount inflation, not deflation, and continue to expect a weaker US dollar.
Over the past three months, selected mining and non-ferrous metals companies have also been outperforming the Topix, including Furukawa Co., Nittetsu Mining, Mitsui Mining and Smelting and Mitsubishi Materials. Ironically, one pattern seen during the current rally in Japanese stocks has been that the companies with the weaker balance sheets have out-performend their peers. This we see as a reflection of a more sanguine view of bankruptcy risk. That said, balance sheet quality still matters, especially after the current overly bullish market sentiment in Japan fades. Thus while it may mean forfeiting some short-term relative performance, we continue to believe that the "quality" stocks (i.e., those with a sound balance sheet) will in the end prevail.
Article by Darrel Whitten
Hmmh, IHUB still has a problem showing the Euro symbol. EUR=?
Ah, I just accidently stumbled in here. Finally a very promising looking Currency board here at IHub. Great.
I find currency speculation the most difficult of all speculations, since so many factors from different countries play into it, making it almost impossible for me to predict despite slow moving trends as a result of liquidity.
Maybe I can learn to improve my currency speculation bottom line here.
So, my first contribution to help kick off this board is a book recommandation (No, I don't know the author). It's about the asian currency crisis in the late 90s. However, it's not outdated since that contagion crisis can repeat and it also provides great backround info usefull once China starts floating it's currency first in a trading band, later free (so the rumor says). It's written by a currency trader Callum Henderson and called "Asia falling?"
- Can anybody here point me to some usefull volume information on currency and currency future trades? It seems like there exists no decent Currency chart with volume information out there.
- It feels like the USDEUR is in for a correction, Maybe down to $1.2/?1, doesn't it? I could be wrong.
- What are the most important factors, numbers that influence the dollar, and to what percentage? I would be very thankfull if any knowledgable person out there could point me into the right direction.
S.
Playing the Weak Dollar
Thursday February 12, 6:04 pm ET
By Steve H. Hanke
If you parked all of your portfolio in the U.S. last year, you missed out. Unhedged foreign funds can enhance your returns while reducing risks.
Investors were thrilled to see the S&P 500 notch up by 26% (plus dividends) during 2003. Sorry to put a damper on the merrymaking, but I must point out that the U.S. equity market's performance was in fact the tenth worst in the world last year. If you parked all of your portfolio in the U.S. in 2003, you missed out.
Developed markets such as Austria, Canada and Sweden turned in performances for their local investors that were similar to the S&P 500's. But an American who invested in those markets would have realized gains of 50% to 60%. The same goes for emerging markets like Thailand, Argentina and Brazil. While a local investor would have roughly doubled his money in any of these markets last year, an American would have chalked up gains of 128% to 141%. The extra return for U.S. investors was due to the decline in value of the greenback. An American investor holding foreign stocks for a year bought, in effect, (relatively) cheap euros or reais or kronor in January and sold those currencies back at higher prices in December.
That was last year. There is no assurance that owning foreign stocks will yield a currency benefit. On the contrary. During 1997-2002, when the dollar was gaining, American investors in foreign markets did worse than the locals.
You have to answer two questions about foreign securities. One is whether you should own them at all. The other is whether to hedge the currency exposure so that you get exactly the returns enjoyed by natives in these foreign markets--no more, no less.
The answer to the first question is a resounding yes. Movements in foreign markets are less than perfectly correlated with those in the U.S. Consequently, foreign investments generate diversification benefits. As a long-term strategy, putting, say, 10% of your portfolio overseas will reduce the risk while increasing your portfolio's likely return.
The answer to the second question is more complicated. My general advice is to build an unhedged international portfolio, then make narrowly targeted side bets against specific foreign currencies when you have reason to believe that the dollar will strengthen. At the moment I would recommend skipping the currency hedges. The dollar is still weak.
Why the weak dollar? At present the Bush Administration's economic policies are perceived by most as being inconsistent, if not incoherent. Consequently, confidence in the dollar is low, and the greenback looks set to continue on its downward course. Indeed, once a currency starts to trend one way or another, it will continue to do so until it provokes a policy response. And there is not much chance of that in a presidential election year, unless the greenback takes a truly dramatic dive. For the short term, U.S. investors should invest in foreign stock and bond funds that do not hedge their foreign exchange risks.
In my last column ("The Wages of War," Dec. 8, 2003) I recommended a portfolio allocation in which 15% of the total was invested in either a U.S. index fund or an exchange-traded U.S. market basket. That should be altered so that 10% of the total portfolio is exposed to foreign stocks and bonds, leaving only 5% of the total in the U.S. stock market. And that foreign exposure should be in foreign mutual funds that do not hedge their exchange risks. (This adjustment bumps the total foreign exchange exposure in my recommended portfolio up to 20%, since the initial allocation to currency trading was 10%.)
Stay unhedged most of the time. Then your foreign stocks will give you diversification of both equities and currencies. The movements of emerging market currencies, for example, tend to be inversely correlated with movements in the dollar, yen, pound and euro. Therefore, holding unhedged positions in both developed and emerging markets will reduce your risk profile.
Does this mean that a U.S. investor who takes advantage of the diversification benefits offered up by foreign investing should never hedge the foreign exchange risk? In a word, no. The best long-term strategy is to invest in foreign funds that are unhedged. Then decide which specific currency risks you don't like and get rid of them. For example, if you are invested in an unhedged Swedish country fund and think the Swedish krona is due to take a tumble against the dollar, manage that currency risk by shorting the krona against the dollar.
By investing in unhedged foreign funds and selectively managing your currency risks, you can reduce your risk in a way that a fund manager--who doesn't know the rest of your portfolio--simply can't.
Steve H. Hanke is a professor of applied economics at The Johns Hopkins University in Baltimore and a senior fellow at the Cato Institute in Washington, D.C. Visit his homepage at www.forbes.com/hanke.
Consumer Sentiment Tumbles in Early Feb
Friday February 13, 10:40 am ET
NEW YORK (Reuters) - U.S. consumer sentiment took an unexpectedly sharp fall in early February as Americans turned cautious over the economy, a survey showed on Friday.
The University of Michigan's preliminary reading of consumer sentiment tumbled to 93.1 in February from January's final reading of 103.8, which was its highest level in over three years, according to market sources who saw the report.
That was way below economists' forecasts of 103.3 and confirmed market speculation the figure would be dramatically lower.
"It is kind of a stunner. A 10-point drop in the confidence index is significant and suggests there is a new pessimism among consumers that was not there a month ago," said Chris Low, chief economist, FTN Financial in New York.
"I suspect it has something to do with three surprisingly weak employment reports in a row," he added.
U.S. Treasury yields gained on the surprisingly weak report, while the dollar slipped, falling to near a record low against the euro (EUR=).
The current conditions index fell to 100.4 from 109.5 in January, while the expectations index dropped to 88.4 from a final reading of 100.1 last month.
The report, which is released only to paying subscribers, was consistent with a consumer sentiment survey put out on Tuesday by Investor's Business Daily, whose index fell to 56.5 in February from 60.6 in January.
Analysts say a wobbly jobs sector has dampened consumer confidence despite a strengthening U.S. economy.
Some, however, have cautioned against reading too much into the report, since it has no bearing on actual spending patterns of consumers. But the dip in consumer sentiment is troubling at this stage of the U.S. recovery, analysts agree. Consumer spending leads to business spending, which leads to more jobs.
The University of Michigan survey is based on telephone interviews with 500 U.S. households over the course of the month on personal finances and business and buying conditions.
The preliminary survey, released about midway through the month, is based on the first 250 interviews.
UPDATE - Treasury's Snow says U.S. should balance budget
Friday February 13, 5:18 pm ET
By Alister Bull
(Recasts lead with China comments)
WASHINGTON, Feb 13 (Reuters) - U.S. Treasury Secretary John Snow said on Friday the government should aim for a balanced budget and promised to hold China's "feet to the fire" to encourage it to loosen the yuan currency's peg to the dollar.
He told the Senate Budget Committee that President George W. Bush's fiscal 2005 budget pledge to halve record deficits was only a step in the right direction.
"We really ought to be pointing towards a convergence to zero. That's where we need to go. We need to get on a path to a truly balanced budget," Snow said during lawmaker questions.
The White House has forecast a record $521 billion budget gap this year. Measured against the economy, that would be the largest since 1992 at 4.5 percent of U.S. GDP.
"The deficit, unless dealt with, poses a threat to the long-term well-being of this country ... leading investors to demand higher premiums which means higher interest rates," Snow said.
The Treasury chief said the deficit was manageable but needed to be reined in, saying the administration's vow to cut it in half by holding the line on spending was only part of the battle.
"If we can do better than that, that's terrific," he said. "But you can only do it through two ways."
"In addition to growing the economy, you've got to cut spending. And spending cuts have to be at the forefront of achieving that objective," he said.
CREDIBILITY GAP
Democrats say the budget is fiscally reckless and that a Bush demand that tax cuts be made permanent makes a mockery of claims the administration is serious about reducing the deficit.
"I think the administration has given the American people little reason to take its deficit promises seriously," said Democratic Sen. Robert Byrd of West Virginia.
Byrd complained that the budget ignored the costs of military operations in Iraq as well as money to address the looming Social Security fiscal crunch as the population ages.
Since taking office, Bush has won tax cuts worth some $1.7 trillion over 10 years and Snow is leading a push for them to be made permanent, saying failure to do so threatens the economic recovery.
Unless extended, the tax reductions will begin expiring at year's end, fully running their course by 2010.
Federal Reserve Chairman Alan Greenspan said on Thursday he would support extending the tax cuts, so long as budget rules were also restored requiring revenue increases or spending cuts to offset the projected 10-year cost of about $1 trillion.
Snow told the Senate panel on Friday the 2001 recession had cut government revenues to "quite low levels" but added that the administration was projecting an improvement to the 18 percent of gross domestic product historical average.
FEET TO FIRE
He was also tackled on trade and the dollar -- topics which enrage U.S. manufacturers who say they are losing out to countries like China, which boosts exports by keeping the yuan low by pegging it tightly to the U.S. currency.
Snow said Beijing plans to gradually relax this regime but needed time to prepare its financial system.
"We have an agreement on that with them. They have acknowledged the need to move to a flexible exchange rate. They rightly point out they can't do it tomorrow because their financial structures are so rudimentary. But they are beginning to take steps," he said.
He noted "increasing talk" that China would move to a partial float or a currency basket, instead of targeting the dollar alone.
But he promised the United States would "hold their feet to the fire on continuing to make forward progress there."
IPO VIEW - Economic uncertainty may crimp pipeline
Sunday February 15, 3:37 pm ET
By Steve James
NEW YORK, Feb 15 (Reuters) - Whether it's how long the war in Iraq will drag on to doubts about who will occupy the White House next year, a degree of uncertainty about the economy is also being felt in the market for initial public offerings.
That's why the pipeline for future IPOs may not be quite as strong as one would expect, given the recent signs of fiscal recovery, said Benjamin Howe, a managing partner of America's Growth Capital, a Boston investment firm that specializes in IPOs.
"There is definitely still pause over the economy, as well as the election and the Middle East crisis," he said.
"The pipeline looks strong, although I would have expected it even stronger with the success of recent IPOs. But it's still strong compared to a year ago."
Howe said 25 IPOs were filed in the third quarter of last year, 31 in the fourth quarter and 20 so far this quarter.
Actually, February has been on fire for IPOs, with at least 17 priced in the first two weeks. So it's no surprise the market would cool off in a week shortened by the President's Day holiday. Only one deal is on the calendar this week, plus another held over from last week.
TECHNOLOGY IS NOT DOMINATING
"It's been a very strong two weeks across the board, with good after-market performance in the teens to 20 percent or more," Howe said. "There's a mix of biotechs and technology, but its coming from a bunch of industries, technology is not dominating."
John Fitzgibbon, an IPO analyst with Redherring.com, an online newsletter, said there was a healthy pipeline of deals despite this week's thin calendar for IPO pricings.
"The filing window has opened at the SEC (Securities and Exchange Commission (News - Websites) ) and there were about a dozen IPOs filed last week."
But Howe said investor uncertainty remains with the presidential elections nearing as well as concerns about the Middle East.
"People wonder whether (President) Bush has a susceptibility (for defeat) in the election," he said. "But even if there is a change and a Democrat becomes president, Bush has pulled out all the stops on the economy and we must pay the price down the road."
Low interest rates can only go up and if exchange rates stay at historic lows against the dollar, China and other countries will have to change their pricing, which would affect trade, Howe said.
Five IPOs were priced last week but one, biopharmaceutical firm Dynavax Technologies, did not get done and is listed as "day-to-day." The big winner was Atheros Communications (ATHR.), which rose 25 percent in its first day of trade.
Only one IPO is on the calendar for this week: Cherokee International Corp., which makes power supply products. But the company cut its planned initial public offering to 6.6 million shares from 7.7 million.
However, the Tustin, California-based company did not change the estimated IPO price of $12 to $14 a share.
Cherokee, which sells its products to the computing and storage and medical industrial markets, said it plans to list its shares on Nasdaq under the symbol "CHRK" (Nasdaq:CHRK - News).
The underwriters, led by Credit Suisse First Boston, have an option to buy up to 990,000 additional shares from selling stockholders to cover over-allotments. The company said it will not receive any proceeds from any sale of stock by stockholders.
Testimony of Chairman Alan Greenspan
Federal Reserve Board's semiannual Monetary Policy Report to the Congress
Before the Committee on Financial Services, U.S. House of Representatives
February 11, 2004
Chairman Greenspan presented identical testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, on February 12, 2004
Mr. Chairman and members of the Committee, I am pleased to be here today to present the Federal Reserve's Monetary Policy Report to the Congress.
When I testified before this committee in July, I reported that conditions had become a good deal more supportive of economic expansion over the previous few months. A notable reduction in geopolitical concerns, strengthening confidence in economic prospects, and an improvement in financial conditions boded well for spending and production over the second half of the year. Still, convincing signs of a sustained acceleration in activity were not yet in evidence. Since then, the picture has brightened. The gross domestic product expanded vigorously over the second half of 2003 while productivity surged, prices remained stable, and financial conditions improved further. Overall, the economy has made impressive gains in output and real incomes; however, progress in creating jobs has been limited.
Looking forward, the prospects are good for sustained expansion of the U.S. economy. The household sector's financial condition is stronger, and the business sector has made substantial strides in bolstering balance sheets. Narrowing credit risk spreads and a considerable rally in equity prices have reduced financing costs and increased household wealth, which should provide substantial support for spending by businesses and households. With short-term real interest rates close to zero, monetary policy remains highly accommodative. And it appears that the impetus from fiscal policy will stay expansionary, on net, through this year. These circumstances all should spur the expansion of aggregate demand in 2004. At the same time, increases in efficiency and a significant level of underutilized resources should help keep a lid on inflation.
In retrospect, last year appears to have marked a transition from an extended period of subpar economic performance to one of more vigorous expansion. Once again, household spending was the mainstay, with real personal consumption spending increasing nearly 4 percent and real outlays on residential structures rising about 10 percent. Last year's reductions in personal income tax rates and the advance of rebates to those households that were eligible for the expanded child tax credit boosted the growth of real disposable personal income. The very low level of interest rates also encouraged household spending through a variety of channels. Automakers took advantage of low interest rates to offer attractive incentive deals, buoying the purchase of new vehicles. The lowest home mortgage rates in decades were a major contributor to record sales of existing residences, engendering a large extraction of cash from home equity. A significant part of that cash supported personal consumption expenditures and home improvement. In addition, many households took out cash in the process of refinancing, often using the proceeds to substitute for higher-cost consumer debt. That refinancing also permitted some households to lower the monthly carrying costs for their homes and thus freed up funds for other expenditures. Not least, the low mortgage rates spurred sales and starts of new homes to very high levels.
These developments were reflected in household financing patterns. Home mortgage debt increased about 13 percent last year, while consumer credit expanded much more slowly. Even though the ratio of overall household debt to income continued to increase, as it has for more than a half-century, the rise in home and equity prices enabled the ratio of household net worth to disposable income to recover to a little above its long-term average. The low level of interest rates and large volume of mortgage refinancing activity helped reduce households' debt-service and financial-obligation ratios a bit. And many measures of consumer credit quality improved over the year, with delinquency rates on consumer loans and home mortgages declining.
A strengthening in capital spending over 2003 contributed importantly to the acceleration of real output. In the first quarter of the year, business fixed investment extended the downtrend that began in early 2001. Capital spending, however, ramped up considerably over the final three quarters of 2003, reflecting a pickup in expenditures for equipment and software. Outlays for high-tech equipment showed particular vigor last year. Even spending on communications equipment, which had been quite soft in the previous two years, accelerated. A growing confidence of business executives in the durability of the expansion, strong final sales, the desire to renew capital stocks after replacements had been postponed, and favorable financial conditions all contributed to the turnaround in equipment spending.
By contrast, expenditures on nonresidential structures continued to contract on balance, albeit less rapidly than in 2001 and 2002. High vacancy rates for office buildings and low rates of capacity utilization in manufacturing evidently limited the demand for new structures. Inventory investment likewise failed to pick up much momentum over the year, as managers remained cautious. Firms finished 2003 with lean inventories relative to sales, an encouraging sign for the expansion of production going forward.
To a considerable degree, the gathering strength of capital spending reflects a substantial improvement in the financial condition of businesses over the past few years. Firms' profits rose steeply during 2003 following smaller gains in the previous two years. The significantly stronger cash flow generated by profits and depreciation allowances was more than adequate to cover rising capital expenditures in the aggregate. As a result, businesses had little need to borrow during 2003. For the nonfinancial business sector as a whole, debt is estimated to have grown just 3-1/2 percent.
Firms encountered very receptive conditions in longer-term credit markets in 2003. Interest rate spreads on both investment-grade and speculative-grade bond issues narrowed substantially over the year, as investors apparently became more confident about the economic expansion and saw less risk of adverse shocks from accounting and other corporate scandals. Corporate treasurers took advantage of the attractive market conditions by issuing long-term debt to lengthen the maturities of corporate liabilities.
As a consequence, net short-term financing was extremely weak. The stock of business loans extended by banks and commercial paper issued by nonfinancial firms declined more than $100 billion over the year, apparently owing to slack demand for short-term credit rather than to a constriction in supply. Interest-rate spreads on commercial paper, like those on corporate bonds, were quite narrow. And although a Federal Reserve survey indicates that banks had continued to tighten lending conditions early in the year, by the second half, terms and standards were being eased noticeably. Moreover, responses to that survey pointed to a lack of demand for business loans until late in the year.
Partly as a result of the balance-sheet restructuring, business credit quality appears to have recuperated considerably over the past few years. Last year, the default rate on bonds fell sharply, recovery rates on defaulted issues rose, the number of rating downgrades moderated substantially, and delinquencies on business loans continued to decline. The improved balance sheets and strong profits of business firms, together with attractive terms for financing in open markets and from banks, suggest that financial conditions remain quite supportive of further gains in capital spending in coming quarters.
The profitability of the business sector was again propelled by stunning increases in productivity. The advance in output per hour in the nonfarm business sector picked up to 5-1/4 percent in 2003 after unusually brisk gains in the previous two years. The productivity performance of the past few years has been particularly striking in that these increases occurred in a period of relatively sluggish output growth. The vigorous advance in efficiency represents a notable extension of the pickup that started around the mid-1990s. Apparently, businesses are still reaping the benefits of the marked acceleration in technology.
The strong gains in productivity, however, have obviated robust increases in business payrolls. To date, the expansion of employment has significantly lagged increases in output. Gross separations from employment, two-fifths of which have been involuntary, are about what would be expected from past cyclical experience, given the current pace of output growth. New hires and recalls from layoffs, however, are far below what historical experience indicates. To a surprising degree, firms seem able to continue identifying and implementing new efficiencies in their production processes and thus have found it possible so far to meet increasing orders without stepping up hiring.
In all likelihood, employment will begin to grow more quickly before long as output continues to expand. Productivity over the past few years has probably received a boost from the efforts of businesses to work off the stock of inefficiencies that had accumulated in the boom years. As those opportunities to enhance efficiency become scarcer and as managers become more confident in the durability of the expansion, firms will surely once again add to their payrolls.
A consequence of the rapid gains in productivity and slack in our labor and product markets has been sustained downward pressure on inflation. As measured by the chain-weighted price index for personal consumption expenditures excluding food and energy, prices rose less than 1 percent in 2003. Given the biases in such indexes, this performance puts measured inflation in a range consistent with price stability--a statutory objective of the Federal Reserve and a key goal of all central banks because it is perceived as a prerequisite for maximum sustainable economic growth.
The recent performance of inflation has been especially notable in view of the substantial depreciation of the dollar in 2003. Against a broad basket of currencies of our trading partners, the foreign exchange value of the U.S. dollar has declined about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise after declining on balance for several years, but the turnaround to date has been mild. Apparently, foreign exporters have been willing to absorb some of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails.
Part of exporters' losses, however, have apparently been offset by short forward positions against the dollar in foreign exchange markets. A marked increase in foreign exchange derivative trading, especially in dollar-euro, is consistent with significant hedging of exports to the United States and to other markets that use currencies tied to the U.S. dollar. However, most contracts are short-term because long-term hedging is expensive. Thus, although hedging may delay the adjustment, it cannot eliminate the consequences of exchange rate change. Accordingly, the currency depreciation that we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United States. On the other side of the ledger, the current account should improve as U.S. firms find the export market more receptive.
* * *
Although the prospects for the U.S. economy look quite favorable, we need to remind ourselves that all forecasts are projections into an uncertain future. The fact that most professional forecasters perceive much the same benign short-term outlook that is our most likely expectation provides scant comfort. When the future surprises, history tells us, it often surprises us all. We must, as a consequence, remain alert to risks that could threaten the sustainability of the expansion.
Besides the chronic concern about a sharp spike in oil or natural gas prices, a number of risks can be identified. Of particular importance to monetary policy makers is the possibility that our stance could become improperly calibrated to evolving economic developments. To be sure, the Federal Open Market Committee's current judgment is that its accommodative posture is appropriate to foster sustainable expansion of economic activity. But the evidence indicates clearly that such a policy stance will not be compatible indefinitely with price stability and sustainable growth; the real federal funds rate will eventually need to rise toward a more neutral level. However, with inflation very low and substantial slack in the economy, the Federal Reserve can be patient in removing its current policy accommodation.
In the process of assessing risk, we monitor a broad range of economic and financial indicators. Included in this group are a number of measures of liquidity and credit creation in the economy. By most standard measures, aggregate liquidity does not appear excessive. The monetary aggregate M2 expanded only 5-1/4 percent during 2003, somewhat less than nominal GDP, and actually contracted during the fourth quarter. The growth of nonfederal debt, at 7-3/4 percent, was relatively brisk in 2003. However, a significant portion of that growth was associated with the record turnover of existing homes and the high level of cash-out refinancing, which are not expected to continue at their recent pace. A narrower measure, that of credit held by banks, also grew only moderately in 2003. All told, our accommodative monetary policy stance to date does not seem to have generated excessive volumes of liquidity or credit.
That said, as we evaluate the risks to the economy, we also assess developments in financial markets. Broad measures of equity prices rose 25 percent in 2003, and technology stocks increased twice as quickly. The rally has extended into this year. And as I noted previously, credit spreads on corporate bonds have narrowed considerably, particularly for speculative-grade issues. This performance of financial markets importantly reflects investors' response to robust earnings growth and the repair of business balance sheets over the past few years. However, history shows that pricing financial assets appropriately in real time can be extremely difficult and that, even in a seemingly benign economic environment, risks remain.
The outlook for the federal budget deficit is another critical issue for policymakers in assessing our intermediate- and long-run growth prospects and the risks to those prospects. As you are well aware, after a brief period of unified budget surpluses around the beginning of this decade, the federal budget has reverted to deficits. The unified deficit swelled to $375 billion in fiscal 2003 and appears to be widening considerably further in the current fiscal year. In part, these deficits are a result of the economic downturn and the period of slower growth that we recently experienced, as well as the earlier decline in equity prices. The deficits also reflect fiscal actions specifically intended to provide stimulus to the economy, a significant step-up in spending for national security, and a tendency toward diminished restraint on discretionary spending. Of course, as economic activity continues to expand, tax revenues should strengthen and the deficit will tend to narrow, all else being equal. But even budget projections that attempt to take such business-cycle influences into account, such as those from the Congressional Budget Office and the Office of Management and Budget, indicate that very sizable deficits are in prospect in the years to come.
As I have noted before, the debate over budget priorities appears to be between those advocating additional tax cuts and those advocating increased spending. Although some stirrings in recent weeks in the Congress and elsewhere have been directed at actions that would lower forthcoming deficits, to date no effective constituency has offered programs to balance the budget. One critical element--present in the 1990s but now absent--is a framework of procedural rules to help fiscal policy makers make the difficult decisions that are required to forge a better fiscal balance.
The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics--especially the retirement of the baby-boom generation beginning in just a few years--mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be.
The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the relatively near term. Long-term interest rates reflect not only the balance between the current demand for, and current supply of, credit, they also incorporate markets' expectations of those balances in the future. As a consequence, should investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible as prospects for outsized federal demands on national saving become more apparent. Such a development could constrain investment and other interest-sensitive spending and thus undermine the private capital formation that is a key element in our economy's growth prospects.
Addressing the federal budget deficit is even more important in view of the widening U.S. current account deficit. In 2003, the current account deficit reached $550 billion--about 5 percent of nominal GDP. The current account deficit and the federal budget deficit are related because the large federal dissaving represented by the budget deficit, together with relatively low rates of U.S. private saving, implies a need to attract saving from abroad to finance domestic private investment spending.
To date, the U.S. current account deficit has been financed with little difficulty. Although the foreign exchange value of the dollar has fallen over the past year, the decline generally has been gradual, and no material adverse side effects have been visible in U.S. capital markets. While demands for dollar-denominated assets by foreign private investors are off their record pace of mid-2003, such investors evidently continue to perceive the United States as an excellent place to invest, no doubt owing, in large part, to our vibrant market system and our economy's very strong productivity performance. Moreover, some governments have accumulated large amounts of dollar-denominated debt as a byproduct of resisting upward exchange rate adjustment.
Nonetheless, given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents. Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth.
The large current account deficits and the associated substantial trade deficits pose another imperative--the need to maintain the degree of flexibility that has been so prominent a force for U.S. economic stability in recent years. The greatest current threat to that flexibility is protectionism, a danger that has become increasingly visible on today's landscape. Over the years, protected interests have often endeavored to stop in its tracks the process of unsettling economic change. Pitted against the powerful forces of market competition, virtually all such efforts have failed. The costs of any new protectionist initiatives, in the context of wide current account imbalances, could significantly erode the flexibility of the global economy. Consequently, creeping protectionism must be thwarted and reversed.
* * *
In summary, in recent years the U.S. economy has demonstrated considerable resilience to adversity. It has overcome significant shocks that, in the past, could have hobbled growth for a much longer period than they have in the current cycle. As I have noted previously, the U.S. economy has become far more flexible over the past two decades, and associated improvements have played a key role in lessening the effects of the recent adverse developments on our economy. Looking forward, the odds of sustained robust growth are good, although, as always, risks remain. The Congress can help foster sustainable expansion by taking steps to reduce federal budget deficits and thus contribute to national saving and by continuing to pursue opportunities to open markets and promote trade. For our part, the Federal Reserve intends to use its monetary tools to promote our goals of economic growth and maximum employment of our resources in an environment of effective price stability.
Canada dollar ends higher, off high, on trade data
Friday February 13, 5:25 pm ET
By Cameron French
TORONTO, Feb 13 (Reuters) - The Canadian dollar soared
early against the U.S. dollar on Friday on news that the U.S.
trade deficit and the Canadian trade surplus widened in
December but by day's end the currency had lost most of its
gains.
Canadian bond prices were largely higher, boosted by weak
U.S. consumer confidence figures and sluggish stock markets.
The Canadian dollar finished at C$1.3163 to the U.S.
dollar, or 75.97 U.S. cents, up from C$1.3189 to the U.S.
dollar, or 75.82 U.S. cents, at Thursday's close.
The currency sprinted to a two-week high of C$1.3069, or
76.52 U.S. cents, at mid-morning, as a trio of economic data
sent the U.S. greenback reeling.
"We had the combination of soft U.S. trade numbers, strong
Canadian trade numbers, and a much weaker than expected
Michigan consumer sentiment," said Jack Spitz, director of
foreign exchange at National Bank of Canada.
"That combination proved deadly for the U.S. dollar."
Canada's trade surplus jumped more than expected to C$5.4
billion in December, while for the year, the trade surplus rose
nearly C$2 billion to C$59.81 billion despite the Canadian
dollar's unprecedented 20 percent rise against the U.S.
dollar.
This comforted investors who have been worried about the
surging currency's dampening effect on the Canadian economy.
Exports account for more than 40 percent of Canada's gross
domestic product.
The U.S. trade deficit, meanwhile, unexpectedly widened
nearly 11 percent in December to a near-record gap of $42.5
billion, while the University of Michigan consumer confidence
survey's preliminary reading was 93.1, worse than expectations
of 103.3.
However, the Canadian currency started faltering after
hitting its two-week highs, as traders began selling euros in
favor of rock-bottom greenbacks.
"The retracement of the euro from within 6 basis points of
its all-time high (against the U.S. dollar) had a cause and
effect on the crosses, which made the Canadian dollar head back
to effectively where it started the day," Spitz said.
Analysts said the diverging trade figures boosted hopes
that the Bank of Canada might hold off on cutting interest
rates, keeping Canada's 1.5 percentage point rate differential
over the United States intact. The rate spread helped drive the
Canadian dollar's 2003 gains against the U.S. currency.
BONDS CLIMB
Canadian bond prices were mostly higher as the weak U.S.
consumer sentiment figures pushed influential U.S. Treasuries
higher, while weaker North American equity markets freed up
cash to invest in bonds.
The rise came in spite of the strong Canadian trade data,
which seemed to reduce expectations that the Bank of Canada
will cut interest rates on March 2.
The Bank of Canada cut its trend-setting overnight
rate to 2.50 percent in January, and promised to cut rates
further if evidence emerged that the stronger Canadian dollar
was putting too much pressure on the domestic economy.
The comparable U.S. fed funds rate is 1 percent.
The only domestic economic data of note next week will be
Friday's consumer price index, which is closely watched by the
Bank of Canada, and could sway the market firmly one way or
another about the chances for a March rate cut.
The two-year bond was unchanged at C$101.03 to yield 2.406
percent, while the 10-year bond gained 10 Canadian cents to
C$106.30 to yield 4.414 percent.
The yield spread between the two-year and 10-year bond
moved to 200.8 basis points from 202.2 at the previous close.
The 30-year bond, due 2029, rose 25 Canadian cents to
C$109.35 to yield 5.088 percent. In the United States, the
30-year treasury yielded 4.926 percent.
The three-month when-issued T-bill yielded 2.17 percent,
unchanged from the previous close.
U.S. trade gap widens, consumer confidence wanes
Friday February 13, 6:12 pm ET
By Doug Palmer
(Adds market closes in paras 7-9)
WASHINGTON, Feb 13 (Reuters) - The U.S. trade deficit widened nearly 11 percent in December as strong U.S. economic growth pulled in record imports and exports inched lower despite a weaker dollar, a government report showed on Friday.
The monthly trade gap hit $42.5 billion, well above the $40.0 billion analysts had forecast. The December figure pushed the 2003 trade shortfall to a record $489.4 billion, up 17 percent from 2002.
Meanwhile, a closely watched survey of consumer sentiment was sharply lower in early February, showing Americans turned increasingly cautious on the economy. Analysts say weak jobs creation has dampened consumer confidence despite a strengthening U.S. economy.
The University of Michigan index of consumer confidence slumped to a surprisingly low 93.1 in February, reversing January's hefty rise to 103.8.
"A 10-point drop in the confidence index is significant and suggests there is a new pessimism among consumers that was not there a month ago," said Chris Low, chief economist at FTN Financial in New York. "I suspect it has something to do with three surprisingly weak employment reports in a row," referring to the Labor Department's closely watched monthly employment report.
The near-record December trade gap pushed the dollar lower initially as traders fretted that the currency's 13-percent fall against a basket of currencies since early 2002 was not enough to fix global trade imbalances. However, later on Friday the dollar recouped its losses on profit-taking in euros.
The sharp fall in consumer confidence sent U.S. Treasury prices higher as investors saw it as a sign the Federal Reserve would be in no rush to raise interest rates. The two-year Treasury note (US2YT=RR) firmed in price, taking yields down to 1.68 percent from 1.71 percent late on Thursday.
But the consumer confidence data took a bite out of stock prices as a possible harbinger of slower economic growth.
The Dow Jones industrial average (^DJI - News) ended down 66.22 points, or 0.62 percent, at 10,627.85, while the broader Standard & Poor's 500 Index (CBOE:^SPX - News) closed down 6.30 points, or 0.55 percent, at 1,145.81.
PRICE IMPACT
The burgeoning trade deficit has weighed on the U.S. dollar, which has the potential to create inflationary pressures as Americans pay more for imported goods.
"(The data are) suggesting the decline we've seen in the the dollar over the last couple of years is not having an impact. It suggests the dollar may still need to fall to help narrow the trade deficit. But there's a risk to higher inflation if it does," said Gary Thayer, chief economist at AG Edwards & Sons in St. Louis.
A separate Labor Department report showed the price of imported goods rose sharply in January, a sign the weaker dollar may finally be making itself felt on the price end.
U.S. import prices rose 1.3 percent last month, the biggest climb since February 2003, after a 0.5 percent advance in December. Wall Street had forecast a milder 0.4 percent gain.
"The weaker dollar and stronger global demand have doubled the year-on-year trend in core import prices in the last 12 months," UBS wrote in a report.
In testimony this week to Congress, Fed Chairman Alan Greenspan seemed comfortable with the dollar's decline, saying foreign companies had so far been able to absorb the impact. He said the weaker currency would also help contain the trade gap as foreign producers export less to the United States.
Analysts said the larger-than-expected trade deficit could require the government to trim its estimate of fourth-quarter economic growth, currently pegged at 4.0 percent.
"It's probably going to knock about 0.4 percent off GDP revisions for the fourth quarter," said David Sloan, an economist with 4Cast in New York.
Imports reached a record $132.8 billion in December, led by higher inflows of petroleum and other industrial supplies. Imports of capital goods such as computer accessories and civilian aircraft and consumer goods like televisions and pharmaceuticals also contributed to the month-on-month gain.
Imports from the European Union (News - Websites) in December hit a record $23.1 billion, while imports from China retreated slightly during the month to $13.2 billion.
U.S. exports were fractionally lower at $90.4 billion, led by a large drop in civilian aircraft and other capital goods, and falls in food and consumer goods. But monthly shipments were still nearly $10 billion above December 2002 levels, a sign the dollar's fall helped boost exports in the past year.
Despite December's jump, some analysts said there was evidence the U.S. trade gap may have peaked.
"The way I'm looking at it is as an average of two months, which would be about $40 billion per month ... Looking through the trend here, it looks like the trade deficit is stabilizing." said Jay Bryson, global economist at Wachovia Securities in Charlotte, North Carolina.
The record trade gap for all of 2003 included record bilateral trade deficits of $124 billion with China and $94.3 billion with the European Union.
U.S. imports increased 8.3 percent to a record $1.51 trillion in 2003, aided by record volume and value for crude oil imports and the highest average oil prices since 1984.
UPDATE - ECB's P.Schioppa praises Boca Raton, snubs Dubai
Sunday February 15, 8:43 am ET
By Christian Plumb
(Recasts, adds more quotes, background)
GENOA, Italy, Feb 15 (Reuters) - European Central Bank executive board member Tommaso Padoa-Schioppa was quoted on Sunday as saying the G7 had done a better job of addressing currency market swings last weekend than last year in Dubai.
Padoa-Schioppa also signalled in an interview with Italian newspaper Il Sole 24 Ore that there was no need for lower euro-zone interest rates, saying that low growth in the 12-nation single currency bloc had nothing to do with the ECB's monetary policy.
Last year's message by the Group of Seven richest nations seemed aimed at pushing the dollar down, something policymakers should refrain from, Padoa-Schioppa said. But in Boca Raton, Florida recently, the G7 fared better.
"While I felt that the Dubai document was ambiguous, the Boca Raton document seems to me to be good," Il Sole quoted Padoa-Schioppa as saying, noting that the main currency charts have by and large ignored the statement this week.
"All the pointers seem to suggest that if there had been a repeat of the Dubai communique, the market response would have been different," Padoa Schioppa said.
The dollar, under pressure from huge U.S. current account and budget deficits, lost some 20 percent against the euro in 2003.
The euro carries the main burden of dollar depreciation, because several Asian countries are keeping their currencies artificially low by pegging them to the greenback or, in the case of Japan, by intervening in currency markets.
"(Boca Raton) explains that greater exchange rate flexibility is necessary in Asia in order to better distribute the adjustment of external imbalances," Padoa-Schioppa said.
But he refused to put more pressure on China to stop pegging the yuan to the dollar and fixing it to a wider basket of currencies, saying China was not suffering from external imbalances and the outcome of the move would be uncertain.
IMBALANCES GROWTH RISK
While the outlook for global recovery this year is much improved compared with earlier forecasts, Padoa-Schioppa sounded a warning note for next year, with a big risk stemming from imbalances such as those in the United States. "The problem of American external imbalances is still going to be there, and it is not going to be quickly resolved," he said. "When the adjustment of a large external deficit comes, it may well imply some kind of slowdown in growth."
But any calls for the ECB to reduce interest rates below their current 2.00 percent record low to give the euro zone a shot in the arm are misguided, Padoa-Schioppa said.
"Our interest rates are the lowest they have ever been in the last 50 years," he said. "No one can argue that if they were even lower, growth in Europe would be on a golden path."
"Quite frankly, I do not believe that the problem of low growth in the euro area has anything to do with our current monetary policy," he added.
The euro zone has seen an upswing in recent months that has been triggered almost entirely by external demand, he said, echoing the ECB's view that stronger global recovery largely offsets the strong euro's slowing effect on exports.
"The confidence indexes allow us to hope for a fresh boost to domestic demand, but we are still awaiting hard confirmation that the prime mover behind our growth has shifted in a significant manner toward domestic demand," Padoa-Schioppa said.
Analysts in a Reuters poll on Monday saw only a slight chance of a further ECB rate cut, unless the euro rises further to sustained levels above $1.35.
RPT-Economy Canada-Spare the deficit, spoil the economy?
Sunday February 15, 11:08 am ET
By Russell Blinch
TORONTO, Feb 15 (Reuters) - It's with Samurai zeal that Canadian finance ministers pledge to balance the books today.
After a period of big deficits at the federal and provincial levels, politicians now would rather fall on their swords than allow a drop of red on their books.
The federal Liberals -- the keepers of the budget-cutting orthodoxy since the mid 1990s -- have managed to post six consecutive budget surpluses and have pared the debt-to-GDP ratio to 44 percent from nearly 70 percent in the period.
It's accepted cannon even at the provincial level that governments must balance the books or face the wrath of financial markets and voters.
A number of major bank economists trooped to Ottawa last Wednesday to reinforce the message, advising Finance Minister Ralph Goodale to not only balance the books but to restore the contingency and prudence reserves.
But a voice, and not out of the wilderness, has emerged to challenge what has been the unthinkable of late.
"While Washington's budgetary insanity makes Ottawa's fiscal probity all the more appealing, balanced budgets are a cross that Canadian finance ministers should not always have to bear," Jeffrey Rubin, chief economist for CIBC World Markets, said in his opening salvo in a Globe and Mail column.
And he repeated as much after meeting with Goodale: "The pendulum has shifted, in my opinion, too far, to the point where we are now losing sight of a fundamental role of fiscal policy, and I think placing an unfair constraint on finance ministers," he told reporters.
Rubin believes that without any debate Ottawa has effectively adopted a "balanced budget resolution" that turns the clock back on 70 years of economic theory and practice.
"Yet if every federal budget must be balanced, if not by constitutional amendment, then by scripture, Ottawa is setting itself up to make some huge fiscal policy errors when the economy turns south," he wrote.
KEYNES BE DAMNED?
Of course it was the economist John Maynard Keynes who gained fame for his advice to governments in the 1930s to ramp up spending to bring an end to the Depression that was gripping much of the world.
In an open letter to U.S. President Roosevelt in 1933, he called for spending on large scale projects, such as the rehabilitation of the railroads. "The object is to start the ball rolling. The United States is ready to roll towards prosperity, if a good hard shove can be given in the next six months."
Some economists, however, say Ottawa and the provinces might not be so dead set against running a deficit if the economy was contracting rather than just slowing, as it is currently. While the economy is still largely on track, they believe fiscal prudence should be paramount.
"I still think it's not a bad starting point for governments to at least try to aim to balance the budget," said Doug Porter, senior economist at BMO Nesbitt Burns.
Rick Egelton, deputy chief economist for Bank of Montreal said: "I share the government's view that you want to try to avoid going into deficit. While debt levels have come down quite a bit they are still relatively high historically."
Egelton said there will be big demands on the federal treasury in the years ahead so it is wise now to keep reducing debt levels, and if the economy does weaken monetary authorities can always lower rates to provide stimulus.
"I don't think the government is arguing that if we were to be hit with a very severe recession that the government should take fiscal action to cut spending and raise taxes."
(Additional reporting by Teresa Ruiz)
(The Canada-Economy column runs every Sunday. Comments or questions can be e-mailed to toronto.newsroom(at)reuters.com.)
At a time when the United States remains tightly focused on its domestic economic problems and its international military adventures of the past two years, Asia has been quietly running up an absolutely staggering surplus of US dollars.
http://www.atimes.com/atimes/Asian_Economy/EG15Dk01.html
Xi Jianhua, the Bank of China's gold business expert, is also quoted saying that it would be "safe and feasible" for China swap to some foreign exchange reserves for gold. The country has a little over 600 tonnes of gold in reserve now ($7.3-bn), and $360 billion in foreign exchange.
http://www.sianews.com/modules.php?name=News&file=article&sid=1289
It is estimated that the dollar is currently overvalued by at least 40%, burdening the United States with a huge trade deficit. Conversely, the euro-zone does not run huge deficits, uses higher interest rates, and has an increasingly larger share of world trade. As the euro establishes its durability and comes into wider use, the dollar will no longer be the world’s only option. At that point, it would be easier for other nations to exercise financial leverage against the United States without damaging themselves or the global financial system as a whole.
http://www.projectcensored.org/publications/2004/19.html
Faced with waning international economic power, military superiority is the United States’ only tool for world domination. Although, the expense of this military control is unsustainable, says William Clark, "one of the dirty little secrets of today's international order is that the rest of the globe could topple the United States from its hegemonic status whenever they so choose with a concerted abandonment of the dollar standard. This is America's preeminent, inescapable Achilles Heel." If American power is ever perceived globally as a greater liability than the dangers of toppling the international order, the U.S. systems of control can be eliminated and collapsed. When acting against world opinion – as in Iraq – an international consensus could brand the United States as a “rogue nation.”
Monetary Policy Report submitted to the Congress on February 11, 2004, pursuant to section 2B of the Federal Reserve Act
Section 2
ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2003 AND EARLY 2004
The pace of economic expansion strengthened considerably in the second half of 2003 after almost two years of uneven and, on balance, sluggish growth. In early 2003, accommodative monetary policy and stimulative fiscal policies were in place, but economic activity still seemed to be weighed down by a number of factors that had restrained the recovery earlier: Geopolitical tensions were again heightened, this time by the impending war in Iraq, businesses remained unusually cautious about the strength of the expansion, and economic activity abroad was still weak. In June the continued lackluster economic growth and a further downshift in inflation from an already low level prompted a further reduction in the federal funds rate. In addition, the tax cuts that became effective at midyear provided a significant boost to disposable income. In the succeeding months, the macroeconomic stimulus began to show through clearly in sales and production, and some of the business caution seemed to recede. Real GDP increased at an annual rate of 6 percent, on average, in the third and fourth quarters of last year. In contrast, between late 2001 and mid-2003, real GDP had risen at an annual rate of only 2-1/2 percent.
During the period of recession and subpar economic expansion, considerable slack developed in labor and product markets. The firming of economic activity in the second half of last year produced modest increases in rates of resource utilization. Sustained efforts by businesses to control costs led to further rapid gains in productivity. As a result, unit labor costs declined, and core rates of inflation continued to slow in 2003; excluding food and energy, the PCE chain-type price index increased just 0.9 percent last year. Measures of overall inflation, which were boosted by movements in food and energy prices, were higher than those for core inflation.
Domestic financial market conditions appeared to become increasingly supportive of economic growth last year. The economic expansion lowered investors’ perception of, and perhaps aversion to, risk, and continued disinflation was interpreted as a sign that monetary policy would remain on hold, even as the economy picked up steam. Although yields on Treasury coupon securities rose modestly on balance over the year, risk spreads on corporate debt narrowed to the point that yields on corporate issues declined. The low-interest-rate environment spurred considerable corporate bond issuance and generated a massive wave of mortgage refinancing activity by households. Equity markets began to rally when the uncertainty over the timing of military intervention in Iraq was resolved. The climb in stock prices continued for the rest of the year, driven by improving corporate earnings reports and growing optimism about the prospects for the economy. At the same time, with economic conditions abroad improving and with concerns about the financing burden of the U.S. current account deficit gaining increased attention in financial markets, the dollar fell appreciably on a trade-weighted basis.
The Household Sector
Consumer Spending
Early in 2003, consumer spending was still rising at about the same moderate pace as in 2001 and 2002. In the late spring and in the summer, however, households stepped up their spending sharply. As a result, in the second half of last year, real personal consumption expenditures rose at an annual rate of 4-3/4 percent after having increased at a rate of just under 3 percent in the first half. Although wage and salary earnings rose slowly during most of the year, the midyear reductions in tax rates and the advance of rebates to households eligible for child tax credits provided a substantial boost to after-tax income. In 2003, real disposable personal income increased 3-1/4 percent, after having risen 3-1/2 percent in 2002. Low interest rates provided additional impetus to household spending by reducing borrowing costs for new purchases of houses and durable goods; they also indirectly stimulated spending by facilitating an enormous amount of mortgage refinancing.
The personal saving rate has fluctuated within a fairly narrow range around 2 percent over the past three years. Although households continued to see the value of their homes appreciate over this period, they also were adjusting to the substantial drop in equity wealth that occurred after the peak in the stock market in 2000. By itself, a fall in the ratio of household wealth to income of the magnitude that households experienced between 2000 and 2002 might have triggered a noticeable increase in the personal saving rate. However, in this case, the tendency for households to save more as their wealth declines appears to have been tempered in part by their willingness to take advantage of the attractive pricing and financing environment for consumer goods.
Real consumer expenditures for durable goods surged more than 11 percent in 2003. Sales of new motor vehicles remained brisk as many consumers responded to the low financing rates and various incentive deals that manufacturers offered throughout the year. Falling prices also made electronic equipment attractive to consumers, and spending on home furnishings likely received a boost from the strength of home sales. Altogether, real outlays for furniture and household equipment jumped 13-1/2 percent in 2003.
In contrast, real consumer expenditures on nondurable goods and on services continued to rise at a moderate pace, on balance, last year. Outlays for food and apparel increased a bit faster than in 2002, and the steady uptrend in spending for medical services was well maintained. However, consumers responded to the higher cost of energy by cutting back their real spending on gasoline, fuel oil, and natural gas and electricity services.
Consumer confidence was shaken temporarily early in 2003 by concerns about the consequences of a war in Iraq, but it snapped back in the spring. Toward year-end, sentiment appeared to brighten more as households saw their current financial conditions improve and gained confidence that business conditions would be better during the year ahead. Those positive views became more widely held in January, and the index of consumer sentiment prepared by the Michigan Survey Research Center (SRC) reached its highest level in three years.
Residential Investment
Housing activity was robust for a second consecutive year in 2003. After having risen 7 percent in 2002, real expenditures on residential construction jumped more than 10 percent in 2003. These gains were fueled importantly by the lowest levels of mortgage interest rates in more than forty years, which, according to the Michigan SRC's survey of consumer sentiment, buoyed consumer attitudes toward homebuying throughout the year. The average rate on thirty-year fixed-rate mortgages dropped sharply during the first half of 2003 and reached a low of 5-1/4 percent in June. Although the thirty-year rate subsequently firmed somewhat, it remained below 6 percent, on average, in the second half of last year.
Construction of new single-family homes accelerated during 2003, and for the year as a whole, starts averaged 1.5 million units, an increase of 10 percent compared with the level in 2002. Sales of both new and existing single-family homes also picked up sharply further last year. The brisk demand for homes was accompanied by rapid increases in the average price paid for them. The average price paid for new homes rose 10 percent over the four quarters of 2003, and the average price of existing homes was up 7-3/4 percent over the same period. However, house price inflation was lower after adjusting for shifts in the composition of transactions toward more expensive homes. The constant-quality price index for new homes, which eliminates the influence of changes in their amenities and their geographic distribution, increased 4-3/4 percent over the four quarters of 2003--down from an increase of 6 percent during 2002. The year-over-year increase in Freddie Mac’s index of the prices paid in repeat sales of existing homes stood at 5-1/2 percent as of the third quarter of 2003, compared with a rise of 7-1/4 percent as of the third quarter of 2002.
Starts in the multifamily sector totaled 350,000 units in 2003, a pace little changed from that of the past several years. Vacancy rates for these units rose and rents fell during the year, but falling mortgage rates apparently helped to maintain building activity.
Household Finance
Household debt increased 10-3/4 percent last year, in large part because of the surge in mortgage borrowing induced by record-low mortgage interest rates. Refinancing activity was torrid in the first half of the year, as mortgage rates declined. Some of the equity that households extracted from their homes during refinancings was apparently used to fund home improvements and to pay down higher-interest consumer debt. When mortgage rates rebounded in the second half of the year, mortgage borrowing slowed from the extremely rapid clip of the first half, but it remained brisk through year-end. Consumer credit increased at a pace of 5-1/4 percent in 2003, a little faster than a year earlier, as revolving credit picked up somewhat from the slow rise recorded in 2002. Despite the pickup in household borrowing, low interest rates kept the household debt-service and financial-obligation ratios--which gauge pre-committed expenditures relative to disposable income--at roughly the levels posted in 2002. Most measures of delinquencies on consumer loans and home mortgages changed little on net last year, and household bankruptcies held roughly steady near their elevated level in 2002.
Even with the rapid expansion in debt, net worth of the household sector increased as the value of household assets rose noticeably. Stock prices were boosted by the rise in corporate earnings and the ebbing of uncertainty about future economic growth. Households directed substantial flows into stock mutual funds in the third and fourth quarters despite highly publicized scandals in the mutual fund industry. Although the companies directly implicated in wrongdoing experienced heavy outflows from their funds, most of these withdrawals apparently were transferred to other mutual funds with little effect on the industry as a whole. A considerable rise in real estate wealth further augmented household assets. Although prices of existing homes climbed more slowly than they had in the previous year, the rate of increase remained sizable. Overall, the advance in the value of household assets outstripped the accumulation of household debt by enough to boost the ratio of net worth to disposable income over the year.
The Business Sector
Fixed Investment
Business spending on equipment and software was still sluggish at the beginning of 2003. However, it accelerated noticeably over the course of the year as profits and cash flow rebounded and as businesses gained confidence in the strength of the economic expansion and in the prospective payoffs from new investment. At the same time, business financing conditions were very favorable: Interest rates remained low, equity values rallied, and the enhanced partial-expensing tax provision gave a special incentive for the purchase of new equipment and software. After having changed little in the first quarter of the year, real outlays for equipment and software increased at an annual rate of 11-3/4 percent over the remaining three quarters of the year.
Outlays for high-technology items--computers and peripherals, software, and communications equipment--which had risen a moderate 4-1/2 percent in 2002, posted a significantly more robust increase of more than 20 percent in 2003. That gain contributed importantly to the pickup in overall business outlays for equipment and software and pushed the level of real high-tech outlays above the previous peak at the end of 2000. The increase in spending last year on computing equipment marked the sharpest gain since 1998, and investment in communications equipment, which had continued to contract in 2002 after having plummeted a year earlier, turned up markedly.
In contrast, the recovery in spending on non-high-tech equipment was, on balance, more muted, in part because outlays for transportation equipment continued to fall. The prolonged slump in business purchases of new aircraft continued in 2003 as domestic air carriers grappled with overcapacity and high fixed costs. By the fourth quarter, real outlays for aircraft had dropped to their lowest level in ten years. In the market for heavy (class 8) trucks, sales were quite slow in early 2003 when businesses were concerned about the performance of models with engines that met new emission standards. But as potential buyers overcame those concerns, sales recovered. By the fourth quarter of 2003, sales of medium and heavy trucks had moved noticeably above the slow pace of 2001 and 2002. Apart from outlays for transportation equipment, investment in other types of non-high-tech equipment was, on balance, little changed during the first half of the year. Demand was strong for medical equipment, instruments, and mining and oilfield machinery, but sales of industrial equipment and farm and construction machinery were sluggish. In the second half of the year, however, the firming in business spending for non-high-tech items became more broadly based.
The steep downturn in nonresidential construction that began in 2001 moderated noticeably in 2003, although market conditions generally remained weak. After having contracted at an average annual rate of 13-1/2 percent during 2001 and 2002, real expenditures for nonresidential construction slipped just 1-1/4 percent, on balance, during 2003. Spending on office buildings and manufacturing structures, which had dropped sharply over the preceding two years, fell again in 2003. The high office vacancy rates in many areas and low rates of factory utilization implied little need for new construction in these sectors even as economic activity firmed. Investment in communications infrastructure, where a glut of long-haul fiber-optic cable had developed earlier, also continued to shrink. In contrast, outlays for retail facilities, such as department stores and shopping malls, turned up last year, and the retrenchment in construction of new hotels and motels ended. In addition, investment in drilling and mining structures, which is strongly influenced by the price levels for crude oil and natural gas, increased noticeably in 2003.
Inventory Investment
During 2002, businesses appeared to have addressed most of the inventory imbalances that had developed a year earlier. But the moderate pace of final demand during the first half of 2003 apparently restrained firms from embarking on a new round of inventory accumulation. Even though final sales picked up in the second half of the year, the restraint seemed to recede only gradually. Over the first three quarters of 2003, nonfarm businesses trimmed their inventories at an average annual rate of $2-3/4 billion in constant-dollar terms, and the preliminary estimate for the final quarter of the year indicated only modest restocking. As a result, most firms appear to have ended the year with their inventories quite lean relative to sales, even after taking into account the downward trend in inventory-sales ratios that has accompanied the ongoing shift to improved inventory management. Motor vehicle dealers were an exception; their days' supply of new vehicles moved higher on average for a second year in a row.
Corporate Profits and Business Finance
Higher profits allowed many firms to finance capital spending with internal funds, and business debt rose only slightly faster than the depressed rate in 2002. Moreover, a paucity of cash-financed merger and acquisition activity further limited the need to issue debt. Gross equity issuance was extremely weak in the first half of the year but perked up in the latter half in response to the rally in equity prices. Nevertheless, for the year as a whole, firms extinguished more equity than they issued.
The pace of gross corporate bond issuance was moderate at the start of the year but shot up in late spring as firms took advantage of low bond yields to pay down short-term debt, to refund existing long-term debt, and to raise cash in anticipation of future spending. Bond issuance by investment-grade firms slowed after midyear as firms accumulated a substantial cushion of liquid assets and as interest rates on higher-quality debt backed up. However, issuance by speculative-grade firms continued apace, with the yields on their debt continuing to decline dramatically presumably because of investors’ increased optimism about the economic outlook and greater willingness to take on risk. The sum of bank loans and commercial paper outstanding, which represent the major components of short-term business debt, contracted throughout the year. In large part, this decline reflected ongoing substitution toward bond financing, but it also was driven by the softness of fixed investment early in the year and the liquidation of inventories over much of the year.
Respondents to the Senior Loan Officer Opinion Survey on Bank Lending Practices noted that terms and standards on business loans were tightened during the first half of the year but that both had been eased considerably by year-end. They also reported that demand for business loans was quite weak for much of the year. However, despite the fact that outstanding levels of business loans continued to decline, survey responses in the last quarter of the year indicated that demand for loans had begun to stabilize. Many banks cited customers’ increased investment and inventory spending as factors helping to generate the increase in loan demand toward the end of the year. The apparent divergence between survey responses and data on actual loan volumes may suggest that demand for lines of credit has increased but that these lines have not yet been drawn. In other short-term financing developments, nonfinancial firms that issued commercial paper in 2003 found a very receptive market, in large part because of the scarcity of outstanding issues. Many of the riskiest borrowers had exited the market in 2002, and remaining issuers improved their attractiveness to investors by continuing to restructure their balance sheets.
Gross equity issuance rose over the course of 2003 as the economic outlook strengthened and stock prices moved higher. The market for initial public offerings continued to languish in the first half of the year but showed signs of life by the end of the summer. The volume of seasoned offerings also picked up in the second half of the year. On the other side of the ledger, merger and acquisition activity again extinguished shares in 2003, although only at a subdued pace. In addition, firms continued to retire a considerable volume of equity through share repurchases. For the year as a whole, net equity issuance was negative.
Corporate credit quality improved, on balance, over the year. Notably, the default rate on corporate bonds declined sharply, delinquency rates on commercial and industrial (C&I) loans at commercial banks turned down, and the pace of bond-rating downgrades slowed considerably. Low interest rates and the resulting restructuring of debt obligations toward longer terms also importantly contributed to improved business credit quality. Bank loan officers noted that the aggressive tightening of lending standards in earlier years was an important factor accounting for the lower delinquency and charge-off rates in recent quarters.
Commercial mortgage debt increased noticeably during most of 2003 despite persistently high vacancy rates, falling rents, and sluggish growth in construction expenditures. Low interest rates on this type of collateralized debt may have induced some corporate borrowers to tap the market to pay down more-costly unsecured debt. Delinquency rates on commercial mortgages generally remained low throughout 2003, and risk spreads were relatively narrow. Loan performance has held up well because of low carrying costs for property owners and because the outstanding loans generally had been structured to include a sizable equity contribution, which makes default less attractive to borrowers.
The Government Sector
Federal Government
The federal budget deficit continued to widen in fiscal year 2003 as a result of the slow increase in nominal incomes, outlays associated with the war in Iraq, and legislative actions that reduced taxes and boosted spending. The deficit in the unified budget totaled $375 billion, up substantially from the deficit of $158 billion recorded in fiscal 2002. The Congressional Budget Office is projecting that the unified federal deficit will increase further in fiscal 2004, to more than $475 billion.
Federal receipts have fallen in each of the past three years; the drop of nearly 4 percent in fiscal 2003 brought the ratio of receipts to GDP to 16-1/2 percent, 2 percentage points below the average for the past thirty years. About half of the decrease in receipts last year was a consequence of legislation that shifted due dates for corporate payments between fiscal years. In addition, personal income tax collections dropped sharply because of the slow rise in nominal wages and salaries, diminished capital gains realizations in 2002, and the tax cuts enacted under the Jobs and Growth Tax Relief Reconciliation Act of 2003. The act advanced refund checks to households eligible for the 2003 increment to the child tax credit and resulted in lower withholding schedules for individual taxpayers. The act also expanded the partial-expensing incentive for businesses, but because corporate profits accelerated sharply last year, corporate tax receipts rose appreciably after adjusting for the shifts in the timing of payments.
At the same time, federal outlays other than for interest expense rose rapidly for the second consecutive year in fiscal 2003; these outlays increased about 9 percent after having risen 11 percent in fiscal 2002. Spurred by operations in Iraq, defense spending soared again, and outlays for homeland security rose further. Spending for income support, such as unemployment insurance, food stamps, and child credits under the earned income tax credit program, also posted a sizable increase. The ongoing rise in the cost and utilization of medical services continued to push up spending for Medicare and Medicaid. Overall, real federal consumption and investment (the measure of federal spending that is included in real GDP) increased 6 percent over the four quarters of 2003, after having risen 10 percent a year earlier.
The federal government had contributed increasingly to national saving in the late 1990s and 2000 as budget deficits gave way to accumulating surpluses. However, with the swing back to large deficits in recent years, the federal government has again become a drain on national saving. Using the accounting practices followed in the national income and product accounts (NIPA), gross federal saving as a percent of GDP dropped sharply in late 2001 and has trended down since then; the drop contributed to a decline in overall gross national saving as a percent of GDP from 18 percent in calendar year 2000 to 13 percent, on average, in the first three quarters of 2003. Federal saving net of estimated depreciation fell from its recent peak of 2-1/2 percent of GDP in 2000 to negative 4 percent of GDP, on average, in the first three quarters of 2003. As a result, despite a noticeable pickup in saving from domestic nonfederal sources, overall net national saving, which is an important determinant of private capital formation, fell to less than 1-1/2 percent of GDP, on average, in the first three quarters of 2003, compared with a recent high of 6-1/2 percent of GDP in 1998.
Federal Borrowing
The Treasury ramped up borrowing in 2003 in response to the sharply widening federal budget deficit, and federal debt held by the public as a percent of nominal GDP increased for a second year in a row after having trended down over the previous decade. As had been the case in 2002, the Treasury was forced to resort temporarily to accounting devices in the spring of 2003 when the statutory debt ceiling became a constraint, but debt markets were not disrupted noticeably. In May, the Congress raised the debt ceiling from $6.4 trillion to $7.4 trillion. With large deficits expected to persist, the Treasury made a number of adjustments to its regular borrowing program, including reintroducing the three-year note, increasing to monthly the frequency of five-year note auctions, reopening the ten-year note in the month following each new quarterly offering, and adding another auction of ten-year inflation-indexed debt. As a result of these changes, the average maturity of outstanding Treasury debt, which had reached its lowest level in decades, began to rise in the latter half of 2003.
State and Local Governments
State and local governments faced another difficult year in 2003. Tax receipts on income and sales continued to be restrained by the subdued performance of the economy. Despite further efforts to rein in spending, the sector’s aggregate net saving, as measured in the NIPA, reached a low of negative $40 billion (at an annual rate), or negative 0.4 percent of GDP, in the first quarter of the year. Most of these jurisdictions are subject to balanced-budget requirements and other rules that require them to respond to fiscal imbalances. Thus, in addition to reducing operating expenses, governments drew on reserves, issued bonds, sold assets, and made various one-time adjustments in the timing of payments to balance their books. In recent years, many have also increased taxes and fees, thereby reversing the trend toward lower taxes that prevailed during the late 1990s.
Recent indications are that the fiscal stress in this sector is beginning to ease. The improvement reflects a noticeable upturn in tax collections in recent quarters while restraint on operating expenditures largely remains in place. On a NIPA basis, real spending on compensation and on goods and services purchased by state and local governments was little changed in the second half of 2003, as it was over the preceding year. However, investment in infrastructure, most of which is funded in the capital markets, accelerated in the second half of 2003. As of the third quarter of 2003, state and local net saving had moved back into positive territory.
State and Local Government Borrowing
Gross issuance of debt by state and local governments was quite robust last year. Weak tax receipts from a sluggish economy, significant demands for infrastructure spending, and low interest rates all contributed to the heavy pace of borrowing. Borrowing was strongest in the second quarter of the year, as governments took advantage of the extraordinarily low longer-term rates to fund capital expenditures and to advance refund existing higher-cost debt. Because of the financial stresses facing these governments, the credit ratings of several states, most notably California, were lowered last year. Although bond downgrades outnumbered upgrades for the sector as a whole, the imbalance between the two was smaller than it was in 2002.
The External Sector
Over the first three quarters of 2003, the U.S. current account deficit widened relative to the comparable period in 2002, a move largely reflecting developments in the deficit on trade in goods and services. Net investment income rose over the same period, as receipts from abroad increased and payments to foreign investors in the United States declined.
International Trade
The trade deficit widened considerably in the first half of 2003 but narrowed slightly in the third quarter, as the value of exports rebounded in response to strengthening foreign economic activity and the depreciation of the dollar. Available trade data through November suggest that the trade deficit narrowed further in the fourth quarter, as an additional strong increase in exports outweighed an increase in imports.
Real exports of goods and services increased about 6 percent in 2003. Exports of services rose about 5 percent. They were held down early in the year by a drop in receipts from foreign travelers, owing to the effects of the SARS (severe acute respiratory syndrome) epidemic and the war in Iraq; services exports rebounded strongly later in the year as those concerns receded. Exports of goods rose about 6-3/4 percent over the course of the year--considerably faster than in 2002. Exports increased in all major end-use categories of trade, with particularly strong gains in capital goods and consumer goods. Reflecting the global recovery in the high-tech sector, exports of computers and semiconductors picked up markedly in 2003, particularly in the second half. By geographic area, exports of goods increased to Western Europe, Canada, and, particularly, to developing countries in East Asia--a region where economic activity expanded at a rapid pace last year. Prices of exported goods rose in 2003, with prices of agricultural exports recording particularly large increases. In response to poor crops and strong demand, prices for cotton and soybeans increased sharply. For beef, disruptions in supply led to notably higher prices through much of 2003. Beef prices, however, fell back in late December after a case of mad cow disease was discovered in the state of Washington and most countries imposed bans on beef imports from the United States.
Real imports of goods and services rose about 3-1/2 percent in 2003. Imports of services fell in the first half of the year but bounced back in the second half, as concerns about the SARS epidemic and the war in Iraq came and went; for the year as a whole, real imports of services were about unchanged from the previous year. Real imports of goods expanded about 4 percent in response to the strengthening of U.S. demand, but the pattern was choppy, with large gains in the second and fourth quarters partially offset by declines in the first and third. Despite a surge in the second quarter, the volume of oil imports increased modestly, on balance, over the course of the year. Real non-oil imports were up about 4-1/2 percent, with the largest increases in capital goods and consumer goods. Imports of computers posted solid gains, whereas imports of semiconductors were flat.
Despite a substantial decline in the value of the dollar, the prices of imported non-oil goods rose only moderately in 2003. By category, the prices of consumer goods were unchanged last year, and prices of capital goods excluding aircraft, computers, and semiconductors increased only a little more than 1 percent. Price increases were larger for industrial supplies. The price of imported natural gas spiked in March and rose again late in the year; these fluctuations were large enough to show through to the overall price index for imported goods. At year-end, prices of industrial metals rose sharply, with the spot price of copper reaching the highest level in six and one-half years. The strength in metals and other commodity prices has been attributed, at least in part, to depreciation of the dollar and strong global demand, particularly from China.
In 2003, the spot price of West Texas intermediate (WTI) crude oil averaged more than $31 per barrel--the highest annual average since the early 1980s. The spot price of oil began to rise at the end of 2002 when ethnic unrest in Nigeria and a nationwide strike in Venezuela sharply limited oil supplies from those two countries. In the first quarter of 2003, geopolitical uncertainty in the period leading up to the war in Iraq also added upward pressure on oil prices. On March 12, the spot price of WTI closed at $37.83 per barrel, the highest level since the Gulf War in 1990. When the main Iraqi oil fields had been secured and it became apparent that the risks to oil supplies had subsided, the spot price of WTI fell sharply to a low of $25.23 per barrel on April 29. However, oil prices began rising again when, because of difficult security conditions, the recovery of oil exports from Iraq was slower than expected. Prices also were boosted in September by the surprise reduction in OPEC’s production target. In the fourth quarter of 2003 and early 2004, strengthening economic activity, falling oil inventories, and the continued depreciation of the dollar contributed to a further run-up in oil prices.
The Financial Account
The financing counterpart to the current account deficit experienced a sizable shift in 2003, as net private inflows fell while foreign official inflows increased. Private foreign purchases of U.S. securities were at an annual rate of about $350 billion through November, about $50 billion lower than in the previous year. Private foreign purchases of U.S. equities continued to recede, and, although the level of bond purchases was little changed in the aggregate, foreign purchases shifted somewhat away from agency bonds and toward corporate bonds. Over the same period, purchases by private U.S. investors of foreign securities increased nearly $80 billion. Accordingly, net inflows through private securities transactions decreased markedly. In contrast, foreign official purchases of U.S. assets surged to record levels in 2003, with the accumulation of dollar reserves particularly high in China and Japan.
Compared with the pace in 2002, foreign direct investment in the United States increased, as merger activity picked up and corporate profits improved. U.S. direct investment abroad held relatively steady at a high level that was largely the result of continued retained earnings. On net, foreign direct investment outflows fell about $50 billion through the first three quarters of 2003.
The Labor Market
Employment and Unemployment
With economic activity still sluggish during the first half of 2003, the labor market continued to weaken. Over the first eight months of the year, private nonfarm payroll employment fell, on average, more than 35,000 per month, extending the prolonged period of cutbacks that began in early 2001. The civilian unemployment rate, which had hovered around 5-3/4 percent for much of 2002, moved up to 6-1/4 percent by June. However, by late in the summer, the labor market began to recover slowly. Declines in private payrolls gave way to moderate increases in employment; over the five months ending in January, private nonfarm establishments added, on average, about 85,000 jobs per month. By January, the unemployment rate moved back down to 5.6 percent.
During the late summer and early fall, prospects for business sales and production brightened, and firms began to lay off fewer workers. Initial claims for unemployment insurance dropped back, and the monthly Current Population Survey (CPS) of households reported a decline in the number of workers who had lost their last job. However, for many unemployed workers, jobs continued to be difficult to find, and the number of unemployed who had been out of work for twenty-seven weeks or more remained persistently high. The labor force participation rate, which tends to be sensitive to workers’ perceptions of the strength of labor demand, drifted lower. Although the CPS indicated a somewhat greater improvement in employment than the payroll report--even after adjusting for conceptual differences between the two measures--the increase in household employment lagged the rise in the working-age population, and the ratio of employment to population fell further during 2003.
The modest upturn in private payroll employment that began in September was marked by a step-up in hiring at businesses supplying professional, business, and education services, and medical services continued to add jobs. Employment in both the construction industry and the real estate industry rose further, although the number of jobs in related financial services dropped back a bit as mortgage refinancing activity slackened. At the same time, although manufacturers were still laying off workers, the monthly declines in factory employment became smaller and less widespread than earlier. Employment stabilized in many industries that produce durable goods, such as metals, furniture, and wood products, as well as in a number of related industries that store and transport goods. In several other areas, employment remained weak. Manufacturers of nondurables, such as chemicals, paper, apparel, and textiles, continued to cut jobs. Employment in retail trade remained, on net, little changed.
Productivity and Labor Costs
Business efforts to increase efficiency and control costs led to another impressive gain in labor productivity last year. Output per hour in the nonfarm business sector surged 5-1/4 percent in 2003 after having risen a robust 4 percent in 2002 and 2-3/4 percent in 2001. What is particularly remarkable about this period is that productivity did not decelerate significantly when output declined in 2001, and it posted persistently strong gains while the recovery in aggregate demand was sluggish. Typically, the outsized increases in productivity that have occurred during cyclical recoveries have followed a period of declines or very weak increases in productivity during the recession and have been associated with rebounds in economic activity that were stronger than has been the case, until recently, in this expansion.
On balance, since the business cycle peak in early 2001, output per hour has risen at an average annual rate of 4 percent--noticeably above the average increase of 2-1/2 percent that prevailed between 1996 and 2000. In the earlier period, an expansion of the capital stock was an important element in boosting the efficiency of workers and their firms; that impetus to productivity has weakened in the recent period as a result of the steep cutbacks in business investment in 2001 and 2002. Instead, the recent gains appear to be grounded in organizational changes and innovations in the use of existing resources--which are referred to as multifactor productivity. The persistence of a rapid rise in multifactor productivity in recent years, along with signs of a pickup in capital spending, suggests that part of the step-up in the rate of increase of labor productivity may be sustained for some time.
In 2003, the employment cost index (ECI) for private nonfarm businesses, which is based on a survey conducted quarterly by the Bureau of Labor Statistics, rose 4 percent--about 3/4 percentage point more than the increase in 2002. Compensation per hour in the nonfarm business sector, which is based on data constructed for the NIPA, is estimated to have increased 3-1/4 percent in 2003, up from 1-1/2 percent in 2002. In recent years, the NIPA-derived series has shown much wider fluctuations in hourly compensation than the ECI, in part because it includes the value of stock option exercises, which are excluded from the ECI. The value of options exercised shot up in 2000 and then dropped over the next two years.
Most of the acceleration in hourly compensation in 2003 was the result of larger increases in the costs of employee benefits. The ECI for wages and salaries rose 3 percent--up slightly from the pace in 2002 but still well below the rates of increase in the preceding six years. Wage gains last year likely were restrained by persistent slack in the demand for labor as well as by the pressure on employers to control overall labor costs in the face of the rapidly rising cost of benefits. Employer costs for benefits, which had risen 4-3/4 percent in 2002, climbed another 6-1/2 percent in 2003. The cost of health insurance as measured by the ECI has been moving up at close to a double-digit rate for three consecutive years. In addition, in late 2002 and early 2003, employers needed to substantially boost their contributions to defined-benefit retirement plans to cover the declines in the market value of plan assets.
Prices
Headline consumer price inflation in 2003 was maintained by an acceleration in food prices and another sizable increase in energy prices, but core rates of inflation fell for a second year. Although the strong upturn in economic activity in the second half of last year began to reduce unemployment and to boost industrial utilization rates, considerable slack in labor and product markets continued to restrain inflation throughout the year. A further moderation in the costs of production also helped to check inflation: As a result of another rapid rise in productivity, businesses saw their unit labor costs decline in 2003 for a second consecutive year. In contrast, prices for imported goods excluding petroleum, computers, and semiconductors increased at about the same rate as prices more generally; between 1996 and 2002, these import prices fell relative to overall prices for personal consumption expenditures (PCE). The chain-type price index for PCE excluding food and energy rose just under 1 percent in 2003, about 3/4 percentage point less than in 2002. A broader measure of inflation, the chain-type price index for GDP, increased 1-1/2 percent in 2003, the same slow pace as in 2002. Both measures of inflation were roughly a percentage point lower than in 2001.
Consumer energy prices fluctuated widely over the four quarters of 2003, and the PCE index for energy was up 7-1/4 percent over the period. In the first quarter of the year, the combination of a further rise in the cost of crude oil, increased wholesale margins for gasoline, and unusually tight supplies of natural gas pushed up consumer energy prices sharply. Although the prices of petroleum-based products turned down when the price of crude oil fell back in March, a number of supply disruptions in late summer resulted in another temporary run-up in the retail price of gasoline. In the spring, the price of natural gas began to ease as supplies improved, but it remained high relative to the level in recent years. Electricity prices also moved up during 2003, in part because of the higher input costs of natural gas. In January 2004, a cold wave in the Northeast, together with the rise in the price of crude oil since early December, once again led to spikes in the prices of gasoline and natural gas.
The PCE price index for food and beverages increased 2-3/4 percent in 2003 after having risen just 1-1/4 percent a year earlier. Much of the acceleration can be traced to strong demand for farm products, but prices paid by consumers for food away from home--which depend much more heavily on the cost of labor than on prices of food products--were up 3 percent in 2003, also somewhat more than overall consumer price inflation. Poor harvests abroad, especially in Europe, contributed importantly to the heightened demand for U.S. farm products. Thus, despite a bumper crop of corn and some other grains in the United States, world stocks were tight and prices remained high. In addition, the U.S. soybean crop was crimped by late-season heat and dryness, which further tightened world supplies. Concerns about the cases of mad cow disease that were identified in herds in Japan and Canada supported strong domestic and export demand for U.S. beef for most of last year while supplies edged down. But, at year-end, when a case of mad cow disease was discovered in a domestic herd, export demand for U.S. beef plunged and drove the price of live cattle down sharply. A portion of the drop in cattle prices likely will show through to consumer prices for beef early this year.
The decline in core inflation in 2003 was broadly based. Prices of core consumer goods fell somewhat faster than a year earlier; the declines were led by larger cuts in prices of apparel, motor vehicles, electronic equipment, and a variety of other durable goods. At the same time, prices of non-energy services rose less rapidly. The deceleration in core consumer prices measured by the CPI is somewhat greater than that measured by the PCE index. In each index, the costs of housing services to tenants and owners rose less in 2003 than in 2002, but because these costs receive a larger weight in the CPI, their slowing contributed a greater amount to the CPI’s deceleration. In addition, the different measurement of the prices of medical services in the two series contributed to the smaller deceleration in non-energy services in the PCE. The medical services component of the CPI, which measures out-of-pocket expenses paid by consumers, increased 4 percent in 2003, down from 5-1/2 percent a year earlier. Alternatively, the PCE for medical services is a broader measure that uses producer price indexes (PPI) to capture the costs of services provided by hospitals and doctors; it continued to increase more slowly than the CPI for medical services last year, 3-1/4 percent, but it was up slightly from its increase of 2-1/2 percent in 2002.
Alternative measures of price change
Percent
Price measure
--------------------------------------------------------------------------------
2001
--------------------------------------------------------------------------------
2002
--------------------------------------------------------------------------------
2003
--------------------------------------------------------------------------------
Chain-type
Gross domestic product 2.4 1.4 1.5
Gross domestic purchases
1.6 1.7 1.6
Personal consumption expenditures 1.6 1.8 1.4
Excluding food and energy 2.1 1.6 0.9
Chained CPI 1.5 1.8 1.4
Excluding food and energy 2.1 1.6 0.6
Fixed-weight
Consumer price index 1.8 2.2 1.9
Excluding food and energy 2.7 2.1 1.2
Note. Changes are based on quarterly averages and are
measured to the fourth quarter of the year indicated from the
fourth quarter of the preceding year.
Survey measures of expected inflation were little changed, on balance, in 2003. According to the Federal Reserve Bank of Philadelphia's survey of professional forecasters, expectations for CPI inflation ten years ahead remained at 2-1/2 percent last year. As measured by the Michigan Survey Research Center survey of households, median five- to ten-year inflation expectations, which averaged 3 percent in 2001, were steady at 2-3/4 percent in 2003 for a second consecutive year. Inflation compensation as measured by the spread between the yield on nominal Treasury securities and their indexed counterparts varied over a wide range in 2003, settling at just under 2-1/2 percent at year-end. Shorter-term inflation expectations also posted some wide swings during 2003; year-ahead expectations in the Michigan SRC survey spiked early in the year with the sharp increase in energy prices and dipped briefly to an unusually low level at midyear as actual inflation eased in response to lower energy prices. However, year-ahead inflation expectations settled back to just over 2-1/2 percent at the end of the year, about the same as at the end of 2002.
The PPI for crude materials excluding food and energy products, which had dropped 10 percent in 2001, rose 11-3/4 percent in 2002 and another 17-1/2 percent in 2003. The upswing was driven by the pickup in demand associated with the acceleration in both domestic and worldwide industrial activity and by the pass-through of higher energy costs. Such wide cyclical swings in commodity prices have only a small effect on movements in the prices of intermediate and finished goods. At later stages of production and distribution, commodity costs represent only a small share of overall costs, and some portion of the change in commodity prices tends to be absorbed in firms' profit margins. Thus, the recent pickup in prices at the intermediate stage of processing has been more muted; after having fallen almost 1-1/2 percent in 2001, the PPI for core intermediate materials rose 1-1/4 percent in 2002 and 2 percent in 2003.
U.S. Financial Markets
On balance, financial market conditions became increasingly supportive of growth over 2003 as investors became more assured that the economy was on solid footing. Equity prices marched up after the first quarter of the year in response to the initiation and swift conclusion of major combat operations in Iraq, positive earnings reports, and--in the second half of the year--a stronger pace of economic growth. Risk spreads on corporate debt declined, with the spreads on the debt of both investment-grade firms and speculative-grade firms ending 2003 at their lowest levels since 1998. Thus, although Treasury coupon yields ended the year 30–40 basis points higher, yields on many corporate bonds ended the year lower. Commercial banks appeared somewhat slower than bond investors to lend at more favorable terms; nevertheless, by late in the year, banks had eased both standards and terms on C&I loans.
Demand for short-term debt, however, remained very weak, and business loans and outstanding commercial paper continued to run off. In response to a widening budget deficit and a rapid expansion of federal debt, the Treasury increased the frequency of its debt auctions. Declines in mortgage interest rates over the first half of the year led to an extraordinary increase in mortgage debt, as originations for home purchase and for refinancings both climbed to record levels.
Interest Rates
Interest rates fell for most of the first half of 2003, primarily in response to continuing weak economic data and an associated marking down of expectations for the federal funds rate. Global uncertainty ran high, particularly surrounding the timing of military intervention in Iraq, which elevated safe-haven demands and depressed yields on Treasury securities. Moreover, the weak March employment report and other disappointing news about economic activity seemed to cause a substantial shift in views about monetary policy. Data from the federal funds futures market suggested a significant probability of a further easing of policy and did not imply any tightening before early 2004. Even as geopolitical tensions eased, weaker-than-expected economic data continued to hold down Treasury yields. The FOMC’s statement following its May meeting that an "unwelcome fall in inflation" remained a risk reinforced the notion that monetary policy would stay accommodative, and, indeed, judging from market quotes on federal funds futures, market participants anticipated further easing. Mortgage rates followed Treasury yields lower, precipitating a huge surge of mortgage refinancing. To offset the decline in the duration of their portfolios stemming from the jump in prepayments, mortgage investors reportedly bought large quantities of longer-dated Treasuries, amplifying the fall in yields. Interest rates on corporate bonds also declined in the first half of the year, prompting many firms to issue long-term debt to pay down other, more expensive forms of debt and build up cash assets. Growing confidence that the frequency and severity of corporate accounting scandals were waning likely contributed to the narrowing in risk spreads. By the end of spring, default rates on corporate bonds had begun to decline, and corporate credit quality appeared to stabilize.
By the time of the June FOMC meeting, federal funds futures data implied that market participants had generally come to expect an aggressive reduction in the target federal funds rate, so the Committee’s decision to lower the target rate by only 25 basis points came as a surprise to some. In addition, some investors were reportedly disappointed that the statement following this meeting included no mention of "unconventional" monetary policy actions that would be aimed at lowering longer-term yields more directly than through changes in the federal funds rate target alone. As a result, market interest rates backed up, with the move probably amplified by the unwinding of mortgage-related hedging activity. The Chairman's monetary policy testimony in July, and the FOMC's statements at subsequent meetings that noted that policy could remain accommodative for "a considerable period," apparently provided an anchor for the front end of the yield curve. At the same time, increasingly positive economic reports bolstered confidence in the markets, and longer-dated Treasury securities ended the year about 40 basis points above their year-earlier levels. But, with the expansion evidently gaining traction and investors becoming more willing to take on risk, corporate risk spreads, particularly those on speculative-grade issues, continued to fall over the second half of the year. Treasury yields fell early in 2004, largely in response to the weaker-than-expected December labor market report. After the release of the Committee's statement following its January meeting, Treasury yields backed up a bit as futures market prices implied an expectation of an earlier onset of tightening than had been previously anticipated.
Equity Markets
Broad equity price indexes ended the year 25 percent to 30 percent higher. Early in the year, stock prices were buffeted by mixed news about the pace of economic expansion and by heightened geopolitical tensions. Rising oil prices boosted the shares of energy companies very early in the year while, by and large, stocks in other sectors were stumbling. By spring, however, positive news on corporate earnings--often exceeding expectations--and easing of geopolitical tensions associated with the initiation of military action in Iraq boosted equity prices significantly. Subsequently, the swift end to major combat operations in Iraq caused implied volatility on the S&P 500 index to fall substantially. Over the rest of the year, increasingly positive earnings results contributed to a sustained rally in stock prices, and implied volatility in equity markets fell further. Corporate scandals--albeit on a smaller scale than in previous years--continued to emerge in 2003, but these revelations appeared to leave little lasting imprint on broad measures of stock prices. For the year as a whole, the Russell 2000 index of small-cap stocks and the technology-laden Nasdaq composite index, which rose 45 percent and 50 percent, respectively, noticeably outpaced broader indexes. To date in 2004, equity markets have continued to rally.
With the sustained rise in stock prices, the ratio of expected year-ahead earnings to stock prices for firms in the S&P 500 edged down over 2003. The gap between this ratio and the real ten-year Treasury yield--a crude measure of the equity risk premium--narrowed a bit over the course of the year, though it remains in the upper part of the range observed over the past two decades.
Debt and Financial Intermediation
Aggregate debt of the domestic nonfinancial sectors is estimated to have increased about 8-1/4 percent in 2003, just over a percentage point faster than in 2002. Federal debt accelerated sharply, rising 11 percent, owing to the larger budget deficit. Household debt rose almost as rapidly, and the increase in state and local government debt also was substantial. In contrast, business borrowing remained subdued last year.
In the business sector, investment spending, particularly in the beginning of the year, was mainly financed with internal funds, limiting, though not eliminating, businesses’ need to increase debt. With long-term rates falling through midyear and credit spreads--especially for riskier borrowers--narrowing, corporate treasurers shifted their debt issuance toward bond financing and away from shorter-term debt. Household borrowing also shifted in response to lower longer-term rates. Mortgage rates followed Treasury rates lower in the spring, and mortgage originations for both home purchases and refinancings surged. Refinancing activity appears to have held down growth of consumer credit as households extracted equity from their homes and used the proceeds, in part, to pay down higher-cost consumer debt. Nevertheless, consumer credit posted a moderate advance in 2003, buoyed by heavy spending on autos and other durables. A substantial widening of the federal deficit forced the Treasury to increase its borrowing significantly. To facilitate the pickup in borrowing, the Treasury altered its auction cycle to increase the frequency of certain issues and reintroduced the three-year note.
Depository credit rose 6 percent in 2003 and was driven by mortgage lending and the acquisition of mortgage-backed securities by both banks and thrift institutions. Consumer lending also was substantial, as lower interest rates and auto incentives spurred spending on durable goods. In contrast, business loans fell 7-1/4 percent over 2003, a drop similar to the runoff in 2002. Survey evidence suggests that the decline in business lending at banks was primarily the result of decreased demand for these loans, with respondent banks often citing weak investment and inventory spending. Moreover, the contraction was concentrated at large banks, whose customers tend to be larger corporations that have access to bond markets, and the proceeds of bond issuance were apparently used, in part, to pay down bank loans. The January 2004 Senior Loan Officer Opinion Survey reported a pickup in business loan demand arising mainly from increased spending on plant and equipment and on inventories. Supply conditions apparently played a secondary role in the weakness in business loans in 2003. Banks tightened standards and terms on business loans somewhat in the first half of the year, but by year-end they had begun to ease terms and standards considerably, in part because of reduced concern about the economic outlook.
The M2 Monetary Aggregate
M2 increased 5-1/4 percent in 2003, a pace somewhat slower than in 2002 and a bit below the rate of expansion of nominal income. The deceleration in M2 largely reflected a considerable contraction in the final quarter of the year after three quarters of rapid growth. The robust growth in money around midyear was concentrated in liquid deposits and likely resulted in large part from the wave of mortgage refinancings, which tend to boost M2 as the proceeds are temporarily placed in non-interest-bearing accounts pending disbursement to the holders of mortgage-backed securities. Moreover, around the middle of the year, the equity that was extracted from home values during refinancings probably provided an additional boost to deposits for a time, as households temporarily parked these funds in M2 accounts before paying down other debt or spending them. In the fourth quarter, M2 contracted at an annual rate of 2 percent, the largest quarterly decline since consistent data collection began in 1959. As mortgage rates backed up and the pace of refinancing slowed, the funds that had been swelling deposits flowed out, depressing M2. The sustained rally in equity markets after the first quarter of the year may also have slowed M2 growth, as expectations of continued higher returns led households to shift funds from M2 assets to equities, a view reinforced by the strong flows into equity mutual funds.
International Developments
Economic growth abroad rebounded in the second half of last year as factors that weighed on the global economy in the first half--including the SARS epidemic and uncertainty surrounding the war in Iraq--dissipated. Foreign growth also was boosted by the strong rebound in the U.S. economy, the revival of the global high-tech sector, and, in many countries, ample policy stimulus.
Strong second-half growth in China stimulated activity in other emerging Asian economies and Japan by raising the demand for their exports. Growth in Japan also was spurred by a recovery in private spending there on capital goods. Economic activity in Europe picked up in the second half, as export growth resumed. Economic growth in Latin America has been less robust; the Mexican economic upturn has lagged that of the United States, and Brazil's economy has only recently begun to recover from the effects of its 2002 financial crisis.
Monetary authorities abroad generally eased their policies during the first half of 2003 as economic activity stagnated. In the second half, market participants began to build in expectations of eventual monetary tightening abroad, and official interest rates were raised by year-end in the United Kingdom and Australia. Canadian monetary policy followed a different pattern; the Bank of Canada raised official interest rates in the spring as inflation moved well above its 1 percent to 3 percent target range but cut rates later in the year and again early this year as slack emerged and inflation moderated. Similarly, lower inflation in Mexico and Brazil allowed authorities to ease monetary policy during 2003. The Bank of Japan maintained official interest rates near zero and continued to increase the monetary base.
In foreign financial markets, equity prices fell, on average, until mid-March but since then have risen in reaction to indications of stronger-than-expected global economic activity. Emerging-market equity indexes outpaced those in the industrial countries in 2003, with markets in Latin America posting particularly strong gains. Around midyear, long-term interest rates declined to multiyear lows in many countries as economic growth slowed and inflationary pressures diminished, but those rates moved higher in the second half as growth prospects improved. Bond spreads came down substantially during the year, both for industrial-country corporate debt and for emerging- market sovereign debt; spreads of the J.P. Morgan Emerging Market Bond Index (EMBI+) over U.S. Treasury securities fell to their lowest levels since before the Russian crisis of 1998. Gross capital flows to emerging markets, however, remained well below their 1997 peak.
The foreign exchange value of the dollar continued to decline last year as concerns over the financing of the large and growing U.S. current account deficit took on greater prominence. The dollar declined 18 percent against the Canadian dollar, 17 percent against the euro, and 10 percent against the British pound and the Japanese yen. In contrast, the value of the dollar was little changed, on net, against the currencies of our other important trading partners, in part because officials of China and of some other emerging Asian economies managed their exchange rates so as to maintain stability in terms of the dollar. Among Latin American currencies, the dollar declined against the Brazilian and Argentine currencies but appreciated against the Mexican peso. On balance, the dollar depreciated 9 percent during 2003 on a trade-weighted basis against the currencies of a broad group of U.S. trading partners.
Industrial Economies
The euro-area economy contracted in the first half of 2003, weighed down in part by geopolitical uncertainty and higher oil prices. In the second half, economic activity in the euro area began to grow as the global pickup in activity spurred a recovery of euro-area exports despite the continued appreciation of the euro. The monetary policy of the European Central Bank (ECB) was supportive of growth, with the policy interest rate lowered to 2 percent by midyear. Consumer price inflation slowed to around 2 percent, the upper limit of the ECB’s definition of price stability. Despite increased economic slack, inflation moved down only a little, partly because the summer drought boosted food prices. For the second straight year, the governments of Germany and France each recorded budget deficits in excess of the 3 percent deficit-to-GDP limit specified by the Stability and Growth Pact. However, in light of economic conditions, European Union finance ministers chose not to impose sanctions.
After a sluggish first quarter, the U.K. economy expanded at a solid pace for the remainder of 2003, supported by robust consumption spending and considerable government expenditure. The Bank of England cut rates in the first half of the year but reversed some of that easing later in the year and early this year as the economy picked up and housing prices continued to rise at a rapid, albeit slower, pace. In June, the British government announced its assessment that conditions still were not right for the United Kingdom to adopt the euro. In December, the British government changed the inflation measure to be targeted by the Bank of England from the retail prices index excluding mortgage interest (RPIX) to the consumer prices index. U.K. inflation currently is well below the objective of 2 percent on the new target index.
The Canadian economy contracted in the second quarter owing to the impact of the SARS outbreak in Toronto on travel and tourism, but it rebounded in the latter half of the year. Canadian economic growth continued to be led by strong domestic demand; consumption remained robust and investment spending accelerated, offsetting the negative effect of Canadian dollar appreciation on both exports and import-competing industries. Canadian consumer price inflation swung widely last year, rising to 4-1/2 percent on a twelve-month basis in February before falling to 1-1/2 percent in November and ending the year at 2 percent. The swing partly reflected movements in energy prices, but changes in auto insurance premiums and cigarette taxes also played an important role.
Japanese real GDP recorded significant growth in 2003 for the second straight year. Private investment spending made the largest contribution to the expansion. Consumer spending remained sluggish as labor market conditions continued to be soft. However, nominal wages stabilized following a sharp drop in 2002, and leading indicators of employment moved higher. Despite an appreciation of the yen late in the year, Japanese exports posted a strong increase in 2003 primarily because of gains in exports to China and other emerging Asian economies. With consumer prices continuing to decline, the Bank of Japan (BOJ) maintained its policy interest rate near zero and eased monetary policy several times during 2003 by increasing the target range for the outstanding balance of reserve accounts held by private financial institutions at the BOJ. The BOJ also took other initiatives last year to support the Japanese economy, including launching a program to purchase securities backed by the assets of small- and medium-sized enterprises. Japanese banks continued to be weighed down by large amounts of bad debt, but some progress was made in resolving problems of insufficient bank capital and in reducing bad-debt levels from their previous-year highs.
Emerging-Market Economies
Growth in the Asian developing economies rebounded sharply in the second half of 2003 after having contracted in the first half. The outbreak of SARS in China and its spread to other Asian economies was the primary factor depressing growth in the first half, and the subsequent recovery of retail sales and tourism after the epidemic was contained was an important factor in the sharp rebound. The pattern of Asian growth also reflected the sharp recovery of the global high-tech sector in the second half after a prolonged period of weakness. Exports continued to be the main engine of growth for the region. However, domestic demand contributed importantly to growth in China, where state-sector investment increased at a rapid clip and a boom in construction activity continued. Supply problems caused food prices and overall consumer prices in China to rise on a twelve-month basis last year, following a period of price deflation during the previous year. In addition, concerns emerged that some sectors of the Chinese economy, particularly the property markets in Beijing and Shanghai, may be overheating.
Korean economic growth turned negative in the first half, as the high level of household debt, labor unrest, and concerns over North Korea's nuclear development depressed private-sector spending. A sharp rise in exports spurred a revival of growth in the second half even as domestic demand remained subdued.
The Mexican economy remained sluggish through much of the year but recently has shown some signs of improvement. After lagging the rise in U.S. production, Mexican industrial production posted strong gains in October and November, although it remains well below the peak it reached in 2000. Exports rose late last year to almost the peak they had reached in 2000. Consumer price inflation came down over the course of 2003 to 4 percent, the upper bound of the 2 percent to 4 percent target range. The Bank of Mexico has left policy unchanged since tightening five times between September 2002 and March 2003, but market interest rates have fallen owing to weakness in economic activity.
The Brazilian economy contracted in the first half of 2003 partly as a result of the 2002 financial crisis and the consequent monetary policy tightening. It then expanded moderately in the second half, boosted by strong export growth and a recovery in investment spending. Brazilian financial indicators improved significantly in 2003, in part because the Brazilian government began to run a substantial primary budget surplus and to reform the public-sector pension system. The Brazilian stock market soared nearly 100 percent last year, and Brazil's EMBI+ bond spread narrowed by nearly two-thirds. As the Brazilian currency stabilized and began to appreciate, Brazil's inflation outlook improved, allowing the central bank to reverse fully its earlier rate hikes and to reduce the overnight interest rate to a multiyear low, although real interest rates remained high.
The Argentine economy rebounded in 2003 from the sharp contraction that occurred in the wake of its financial crisis in 2001–02. Still, economic activity remains far below pre-crisis levels, and many of Argentina’s structural problems have not been addressed. With the government still in default to its bondholders, the country’s sovereign debt continued to carry a very low credit rating, and its EMBI+ spread remained extremely high. Even so, the Argentine peso appreciated on balance in 2003, and the Merval stock index nearly doubled over the course of the year.
http://www.federalreserve.gov/boarddocs/hh/2004/february/ReportSection2.htm
MONETARY POLICY AND THE ECONOMIC OUTLOOK
The economic expansion in the United States gathered strength during 2003 while price inflation remained quite low. At the beginning of the year, uncertainties about the economic outlook and about the prospects of war in Iraq apparently weighed on spending decisions and extended the period of subpar economic performance that had begun more than two years earlier. However, with the support of stimulative monetary and fiscal policies, the nation's economy weathered that period of heightened uncertainty to post a marked acceleration in economic activity over the second half of 2003. Still, slack in resource utilization remained substantial, unit labor costs continued to decline as productivity surged, and core inflation moved lower. The performance of the economy last year further bolstered the case that the faster rate of increase in productivity, which began to emerge in the late 1990s, would persist. The combination of that favorable productivity trend and stimulative macroeconomic policies is likely to sustain robust economic expansion and low inflation in 2004.
At the time of our last Monetary Policy Report to the Congress, in July, near-term prospects for U.S. economic activity remained unclear. Although the Federal Open Market Committee (FOMC) believed that policy stimulus and rapid gains in productivity would eventually lead to a pickup in the pace of the expansion, the timing and extent of the improvement were uncertain. During the spring, the rally that occurred in equity markets when the war-related uncertainties lifted suggested that market participants viewed the economic outlook as generally positive. By then, the restraints imparted by the earlier sharp decline in equity prices, the retrenchment in capital spending, and lapses in corporate governance were receding. As the price of crude oil dropped back and consumer confidence rebounded last spring, household spending seemed to be rising once again at a moderate rate. Businesses, however, remained cautious; although the deterioration in the labor market showed signs of abating, private payroll employment was still declining, and capital spending continued to be weak. In addition, economic activity abroad gave few signs of bouncing back, even though long-term interest rates in major foreign economies had declined sharply. At its June meeting, the FOMC provided additional policy accommodation, given that, as yet, it had seen no clear evidence of an acceleration of U.S. economic activity and faced the possibility that inflation might fall further from an already low level.
During the next several months, evidence was accumulating that the economy was strengthening. The improvement was initially most apparent in financial markets, where prospects for stronger economic activity and corporate earnings gave a further lift to equity prices. Interest rates rose as well, but financial conditions appeared to remain, on net, stimulative to spending, and additional impetus from the midyear changes in federal taxes was in train. Over the remainder of the year, in the absence of new shocks to economic activity and with gathering confidence in the durability of the economic expansion, the stimulus from monetary and fiscal policies showed through more readily in an improvement in domestic demand. Consumer spending and residential construction, which had provided solid support for the expansion over the preceding two years, rose more rapidly, and business investment revived. Spurred by the global recovery in the high-tech sector and by a pickup in economic activity abroad, U.S. exports also posted solid increases in the second half of the year. Businesses began to add to their payrolls, but only at a modest pace that implied additional sizable gains in productivity.
The fundamental factors underlying the strengthening of economic activity during the second half of 2003 should continue to promote brisk expansion in 2004. Monetary policy remains accommodative. Financial conditions for businesses are quite favorable: Profits have been rising rapidly, and corporate borrowing costs are at low levels. In the household sector, last year's rise in the value of equities and real estate exceeded the further accumulation of debt by enough to raise the ratio of household net worth to disposable income after three consecutive years of decline. In addition, federal spending and tax policies are slated to remain stimulative during the current fiscal year, while the restraint from the state and local sector should diminish. Lastly, the lower foreign exchange value of the dollar and a sustained economic expansion among our trading partners are likely to boost the demand for U.S. production. Considerable uncertainty, of course, still attends the economic outlook despite these generally favorable fundamentals. In particular, questions remain as to how willing businesses will be to spend and hire and how durable will be the pickup in economic growth among our trading partners. At its meeting on January 27-28, 2004, the Committee perceived that upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal.
Prospects for sustained high rates of increase in productivity are quite favorable. Businesses are likely to retain their focus on controlling costs and boosting efficiency by making organizational improvements and exploiting investments in new equipment. With the ongoing gains in productivity, the existing margins of slack in resource utilization should recede gradually, and any upward pressure on prices should remain well contained. The FOMC indicated at its January meeting that, with inflation low and resource use still slack, it can be patient in removing its policy accommodation.
Monetary Policy, Financial Markets, and the Economy over 2003 and Early 2004
During the opening months of 2003, the softness in economic conditions was exacerbated by the substantial uncertainty surrounding the onset of war in Iraq. Private nonfarm businesses began again to cut payrolls substantially, consumer spending slowed, and business investment was muted. Although the jump in energy prices pushed up overall inflation, slack in resource utilization and the rapid rise in labor productivity pushed core inflation down. In financial markets, the heightened sense of caution among investors generated safe-haven demands for Treasury and other fixed-income securities, and equity prices declined.
At its meeting on March 18, the FOMC maintained its 1-1/4 percent target for the federal funds rate to provide support for a stronger economic expansion that appeared likely to materialize. The Committee noted that the prevailing high degree of geopolitical uncertainty complicated any assessment of prospects for the economy, and members refrained from making a determination about the balance of risks with regard to its goals of maximum employment and stable prices. At the same time, the Committee agreed to step up its surveillance of the economy, which took the form of a series of conference calls in late March and early April to consult about developments. When military action in Iraq became a certainty, financial markets began to rally, with risk spreads on corporate debt securities narrowing and broad equity indexes registering notable gains. Economic news, however, remained mixed.
Indicators of the economy at the time of the May 6 FOMC meeting continued to suggest only tepid growth. Uncertainty in financial markets had declined, and rising consumer confidence and a wave of mortgage refinancing appeared to be supporting consumer spending. However, persistent excess capacity evident in labor and product markets pointed to possible further disinflation. The lifting of some of the uncertainty clouding the economic outlook allowed the Committee to make the determination that the risks to economic growth were balanced but that the probability of an unwelcome substantial fall in inflation exceeded that of a pickup in inflation. The FOMC judged that, taken together, the balance of risks was weighted toward weakness. The Committee left the federal funds rate target at 1-1/4 percent, but the Committee's announcement prompted a rally in the Treasury market, and coupon yields fell substantially as market participants marked down their expectations for the path of the federal funds rate.
By the time of the June 24-25 FOMC meeting, risk spreads had narrowed further and equity prices had extended their rise, but the prospects for sustained economic expansion still seemed tentative. Although Committee members referred to signs of improvement in some sectors of the economy, they saw no concrete evidence of an appreciable overall strengthening in the economic expansion and viewed the excess capacity in the economy as likely to keep inflation in check. The Committee lowered the target for the federal funds rate 1/4 percentage point, to 1 percent, to add further support to the economic expansion and as a form of insurance against a further substantial drop in inflation, however unlikely. The members saw no serious obstacles to further conventional policy ease down to the zero lower bound on nominal interest rates should that prove to be necessary. The Committee also discussed alternative means of providing monetary stimulus should the target federal funds rate be reduced to a point at which they would have little or no latitude for additional easing through this traditional channel.
Longer-term interest rates backed up following the meeting, as investors had apparently placed substantial odds on a policy move larger than 25 basis points and may have been disappointed that the announcement failed to mention any potential "unconventional" monetary policy options. Ten-year Treasury yields rose sharply during the following weeks in reaction to interpretations of the Chairman's congressional testimony, the release of Committee members' economic projections, and positive incoming news about the economy and corporate profits. A substantial unwinding of hedging positions related to mortgage investments may well have amplified the upswing in market yields. Over the intermeeting period, labor markets continued to be soft, but industrial production, personal consumption expenditures, and business outlays all strengthened, and the housing market remained robust. By the time of the August 12 FOMC meeting, members generally perceived a firming in the economy, most encouragingly in business investment spending, and believed that, even after the rise in longer-term rates, financial conditions were still supportive of vigorous economic growth. Given the continued slack in resource use across the economy, however, members saw little risk of inducing higher inflation by leaving the federal funds rate at its accommodative level. On the basis of the economic outlook, and to reassure market participants that policy would not reverse course soon, Committee members decided to include in the announcement a reference to their judgment that under the anticipated circumstances, policy accommodation could be maintained for a "considerable period."
Through the September 16 and October 28 FOMC meetings, the brightening prospects for future growth put upward pressure on equity prices and longer-term interest rates. The Committee's retention of the phrase "considerable period" in the announcements following each of these meetings apparently provided an anchor for near-term interest rates. The Committee's discussion at these two meetings focused on the increased evidence of a broadly based acceleration in economic activity and on the continued weakness in labor markets. Rising industrial production, increased personal consumption and business investment spending, higher profits, receptive financial markets, and a lower foreign exchange value of the dollar all suggested that sustained and robust economic growth was in train. The Committee's decision to leave the stance of monetary policy unchanged over this period reflected, in part, a continuing confidence that gains in productivity would support economic growth and suppress inflationary pressures. In fact, the Committee generally viewed its goal of price stability as essentially having been achieved.
By the time of the December 9 FOMC meeting, the economic expansion appeared likely to continue at a rate sufficient to begin to reduce slack in labor and product markets. Equity markets continued to rally, and risk spreads, particularly on the debt of speculative-grade firms, narrowed further. The labor market was finally showing some signs of improvement, and spending by households remained strong even as the impetus from earlier mortgage refinancings and tax cuts began to wane. The acceleration in capital spending and evidence that some firms were beginning to accumulate inventories seemed to signal that business confidence was on the mend. However, twelve-month core consumer price inflation was noticeably lower than in the previous year. Even though the unemployment rate was expected to move down gradually, continued slack in labor and product markets over the near term was viewed as sufficient to keep any nascent inflation subdued. Uncertainty about the pace at which slack would be worked down, however, made longer-run prospects for inflationary pressures difficult to gauge. Given the better outlook for sustained economic growth, the possibility of pernicious deflation associated with a pronounced softening in real activity was seen as even more remote than it had been earlier in the year. The Committee indicated that keeping policy accommodative for a considerable period was contingent on its expectation that inflation would remain low and that resource use would remain slack.
At its meeting on January 27-28, 2004, the Committee viewed a self-sustaining economic expansion as even more likely. Members drew particular reassurance from reports of plans for stronger capital spending and the widespread distribution of increased activity across regions. Accommodative financial market conditions, including higher equity prices, narrower risk spreads on bonds, and eased standards on business loans, also seemed supportive of economic expansion. However, some risks remained in light of continued lackluster hiring evidenced by the surprisingly weak December payroll employment report. With the likelihood for rapid productivity growth seemingly more assured, Committee members generally agreed that inflation pressures showed no sign of increasing and that a bit more disinflation was possible. Under these circumstances, the Committee concluded that current conditions allowed monetary policy to remain patient. As to the degree of policy accommodation, the Committee left its target for the federal funds rate unchanged. The Committee's characterization that policy could be patient instead of its use of the phrase "considerable period" in its announcement prompted a rise in Treasury yields across the yield curve and a fall in equity prices.
Economic Projections for 2004
Federal Reserve policymakers expect that the economic expansion will continue at a brisk pace in 2004. The central tendency of the forecasts of the change in real gross domestic product made by the members of the Board of Governors and the Federal Reserve Bank presidents is 4-1/2 percent to 5 percent, measured from the final quarter of 2003 to the final quarter of 2004. The full range of these forecasts is somewhat wider--from 4 percent to 5-1/2 percent. The FOMC participants anticipate that the projected increase in real economic activity will be associated with a further gradual decline in the unemployment rate. They expect that the unemployment rate, which has averaged 5-3/4 percent in recent months, will be between 5-1/4 percent and 5-1/2 percent in the fourth quarter of the year. With rapid increases in productivity likely to be sustained and inflation expectations stable, Federal Reserve policymakers anticipate that inflation will remain quite low this year. The central tendency of their forecasts for the change in the chain-type price index for personal consumption expenditures (PCE) is 1 percent to 1-1/4 percent; this measure of inflation was 1.4 percent over the four quarters of 2003.
http://www.federalreserve.gov/boarddocs/hh/2004/february/ReportSection1.htm
On July 6 of 2001, the euro was valued at approximately .8350 US dollars. At its peak value in the last week of May, the euro could be converted at a rate of circa 1.1940 US dollars – an increase of nearly 43%. What events caused this dramatic rise in value, and how could a trader have foreseen it so as to profit accordingly?
Currency Pairs
Data provided by: http://www.fxcmmini.com/index.html
Free Charts
http://quote.fxtrek.com/misc/fxcm.asp
More Links: www.kitco.com
Expect the dollar to fall to 140 to the Euro and 100 Yen to the Dollar before major interventionist policies kick in by the G8.
Soros, Buffet and other's in the know have major short positions on the dollar.
Dollar Drops Further Against Euro
(Bloomberg)Thursday, 27th November, 2003 - The dollar had its biggest
decline against the euro in a week on concern the U.S. won't attract
enough capital to narrow its record current account deficit, even as
the economy expands at the fastest pace since 1984.
The dollar failed to rally after government and industry reports
showed durable goods orders in the U.S. rose, jobless claims fell and
an index of Chicago-area factory activity rose to the highest in
almost nine years. In contrast to the U.S., the euro region's current
account surplus widened in September, the European Central Bank said
today.
"Traders don't feel comfortable sleeping at night with a big long
dollar position,'' said Shahab Jalinoos, a currency strategist at ABN
Amro Holding NV in London.
In New York trading, the dollar fell to $1.1935 per euro at 1:52 p.m.
from $1.l792 late yesterday. The dollar is down 14 percent versus the
euro this year and today dropped against all but three of 16 major
currencies tracked by Bloomberg News.
The U.S. dollar index, which tracks the dollar compared with a basket
of six currencies, fell to 90.58 from 91.46. The index has shed 11
percent this year. In other trading, the yen rose against the dollar
after Merrill Lynch & Co. raised its forecasts for the Japanese
currency. Gold rose.
The U.S. current account, the broadest measure of trade and
investment, was $138.7 billion in the second quarter, the most recent
figures available. By contrast, Europe's surplus widened to 7.7
billion euros in September, the ECB said today. Japan also has a
surplus.
Deficits
"Clearly the growth story is not motivating foreign exchange
markets,'' said John McCarthy, director of foreign exchange trading at
ING Financial Markets LLC in New York. ``The more broad-based
macroeconomic issues of deficits here and general concern about fiscal
issues here, in particular with the Middle East, are going to be with
us for a while.''
Tax cuts, increases in military spending and a growing need to fund
social programs associated with an aging population are widening the
U.S. budget deficit. Wall Street firms including Merrill have forecast
the gap will be a record $600 billion in the fiscal year starting Oct.
1, from $374 billion a year earlier.
In a move that may add to the deficit, the U.S. House of
Representatives approved a $395 billion Medicare bill to help the
elderly afford prescription drugs.
Thanksgiving Holiday
Traders are also reluctant to buy the dollar before the Thanksgiving
holiday in the U.S. on concern the U.S. and its allies will be the
target of terrorist attacks, said Jay Bryson, global economist at
Wachovia Corp. in Charlotte, North Carolina.
"Nobody wants to go into this holiday weekend long dollars,'' said
Bryson. 'It's a flight away from the U.S.''
Britain's Foreign Office yesterday warned that further attacks may be
"imminent'' in the Turkish cities of Istanbul and Ankara. Twenty-nine
people died in Nov. 20 attacks on the British consulate and the
Turkish headquarters of HSBC Holdings Plc. A week earlier, two
synagogues in Istanbul were bombed.
Markets in the U.S., which the Bank for International Settlements
estimates accounts for 16 percent of global foreign exchange trading,
will be closed Thursday for the holiday.
U.S. gross domestic product expanded 8.2 percent in the third quarter,
the Commerce Department said yesterday. That compared with a previous
estimated of 7.2 percent reported on Oct. 30.
"The figures coming out of the American economy are very positive,''
Mervyn Davies, chief executive officer of Standard Chartered Plc, said
at a British Chamber of Commerce luncheon in Hong Kong. ``Everyone
hopes that will continue, but we have seen a marked deterioration and
weakness in the dollar.''
Standard Chartered was the most accurate forecaster of exchange rates
in the third quarter among 56 companies surveyed by Bloomberg News.
Davies said he expects the dollar to extend its slide. It fell to a
record low of $1.1980 per euro last week.
Volkswagen Hurt
"The euro won't weaken against the dollar,'' Bernd Pischetsrieder,
chief executive officer of Volkswagen AG, said in a televised
interview with Bloomberg News. "Whether it's $1.15 or $1.25, it won't
come back to parity.'' The euro's advance will contribute to a decline
in U.S. sales next year, he said.
Orders for durables, or items made to last at least three years, rose
3.3 percent in October, following a 2.1 percent gain in September, the
Commerce Department reported in Washington. Economists expected a 0.7
percent rise, the median estimate in a survey of economists by
Bloomberg News prior to the report.
Applications for initial unemployment insurance fell to 351,000 in the
week ended Saturday, as companies retain and add workers in an
expanding economy, the Labor Department reported. The claims were
lower than the revised 362,000 of the prior week and were the lowest
since 339,000 for the Jan. 20, 2001 week.
Merrill Forecast
Against the yen, the dollar weakened to 109.12 from 109.40. Merrill
said in a report that it expects the yen to strengthen more against
the dollar in 2004 than it previously forecast as the Japanese economy
pulls out of a 12-year slump.
The Japanese currency will end next year at 90 per dollar, that's
stronger than a earlier prediction of 98. Merrill, in a note to
investors, also said it predicts the pound will advance more than
previously estimated against the U.S. currency.
The pound will trade at $1.77 in March, up from a forecast of $1.67.
By September, the U.K. currency will strengthen to $1.85, up from a
prediction of $1.66.
IS THE U.S. DOLLAR'S COLLAPSE UNSTOPPABLE...?
Mon, 01 Dec 2003 22:37:02 -0600
In a telling exchange that the major media 'avoided' reporting,
outgoimg European Central Banker Wim Duisenberg ‘hopes and prays' that the ‘unavoidable adjustment of the dollar will be slow and
gradual'...!
‘The flight of global investors from the dollar has serious
implications, not only for the health of markets such as Japan's, but
because of the peril to the US economy and thus the global economy as
well, for which the United States has acted as economic engine and
importer of last the resort. The US must take in $55 billion per day
in investment in government paper and securities to fund the enormous
deficits in its fiscal budget and its current account, the total
balance of goods and services it trades with other countries. The
current account deficit is expected to hit more than $540 billion in
2003, with the fiscal deficit trending towards $600 billion when
off-budget liabilities are factored in...
The outgoing European Central Bank president, Wim Duisenberg, said
last week that he was praying that what he called the unavoidable fall
in the dollar would be gradual..."The dollar is the currency of a
country with a huge deficit on its balance of payments, close to 5
percent of its GDP [gross domestic product],"Duisenberg told
reporters. "You can afford this one year, two years, maybe five years,
but sometime there has to be an adjustment of its currency," he said.
"We hope and pray that this adjustment, which is unavoidable, will be
slow and gradual. We will do everything in our power to make it slow
and gradual." - ‘Japan: The Rapid Run On Dollar Assets' by Hussain
Khan, Asia Times, Oct 10th, 2003
Penny--Which way will we have movement on the $ after this weekends meeting? Thanks--Peaceb2u
Don't know when they did it.
Wow! If they did that on Tues their short term timing stinks
Peaceb2u
Hancock Bets On A Weak Dollar
BondWeek
January 27, 2004
John Hancock Advisors is putting cash to work in foreign bonds to take advantage of a weak dollar. Fred Cavanaugh, senior v.p. and portfolio manager of the $1.5 billion Strategic Income Fund, plans to maintain the fund's 65% exposure to foreign markets by adding new bonds as older ones mature. He expects foreign debt will outperform on a dollar basis given his view that the greenback is headed for a prolonged downturn. Cavanaugh says his main focus is picking up yield in the foreign markets through factors such as currency appreciation. "We've really tied our strategy to a declining dollar," he saying, adding he sees a continuing devaluation of the dollar for another year or two or possibly longer. The fund holds Canadian, European and Asian bonds. The overall portfolio consists of 46% high-quality sovereigns and 19% emerging markets. Half of the fund is in non-dollar assets. Cavanaugh declined to discuss specific credits he may buy or sell.
In dollar assets, the fund holds 18% of its portfolio in high yield corporate bonds, 14% in Treasuries and 3% in cash and equity. Cavanaugh notes the high-yield allocations remain diverse, listing leisure, transportation, and utilities as some of the sectors in which he invests. He declined to mention any specific company names. Cavanaugh states that high-yield spreads are currently pretty tight and he doesn't see much value left there, although he doesn't plan to change the existing allocation. "We think that high yield had a fabulous year last year," he notes, adding that he expects spread widening as this year continues. He says he is watching the U.S. economy very closely and that if it shows some strength in the coming months he might be attracted to the high yield market more quickly as spreads would likely tighten further. He'll also look at possibly adding junk bonds if high-yield spreads widen and create a buying opportunity. Cavanaugh gauges the fund's performance against the Lipper Multi-Sector Income Fund. The firm manages more than $10 billion in fixed income.
http://www.institutionalinvestor.com
Meet the Un-Enron: Banking's Next Top Gun
By Fraser P. Seitel
In the 1970s, three commercial banks dominated the world. Chase Manhattan. Bank of America. Citibank. Each sat atop more than $100 billion in assets and deposits.
Just below the Big 3 in rank were a host of banking behemoths, headquartered in New York, Chicago and California. These money center banks -- with names like Chemical, Manufacturers Hanover, Morgan Guaranty, Continental, First National Bank of Chicago, Crocker, Security Pacific and 10 or 15 others -- dominated the U.S. commercial banking landscape. Each competed aggressively for corporate business, was dominant in its own statewide retail market (to which banks were restricted by law), and were generally led by strong, outspoken leaders.
The "strongest" of these banking leaders were the men who led the Big 3, singular CEOs, not only household names in the world of finance but in the world at large.
Chase was run by David Rockefeller, scion of American nobility, a global business statesman, as comfortable with presidents and kings as he was with bankers and borrowers.
Tom Clausen ran the Bank of America. A tough talking, no nonsense, roll up your sleeves banker, who later became president of the World Bank.
Citibank was ruled by Walter Wriston, a financial services innovator, who combined great banking acumen with international clout.
In the subsequent three decades, the banking terrain -- like most other terrains -- has changed dramatically.
Mega-mergers have vanquished the venerable names. Chemical merged with Manufacturers Hanover and then with Chase and later with Morgan. Bank of America was subsumed by upstart Nation's Bank, itself the successor to the genteel Citizens and Southern Bank and various others. Citibank shunned banking partners and instead united with the mammoth Traveler's Insurance Company.
The end result of all this merging is that while three decades ago the Big 3 commercial banks led a robust banking industry, today those same Big 3 are the banking industry.
Citigroup boasts assets in excess of $1.19 trillion; JP Morgan Chase, $1.1 trillion; and Bank of America, just under $1 trillion. Their nearest U.S. banking rival is Wells Fargo, weighing in at a "puny" $370 billion in assets.
One casualty of this merger merry-go-round was the loss of CEO leadership in the banking industry, despite the size and power of the institutions created. In the years after Rockefeller-Clausen-Wriston, precious few bank CEOs have ventured beyond the cozy confines of their corporate quarters to emerge as national or even industry leaders. They are largely unknowns.
Indeed, while many may recognize the names of Microsoft's Bill Gates or Steve Ballmer, Dell's Michael Dell, Disney's Michael Eisner, Hewlett Packard's Carly Fiorina, or even Time Warner's Dick Parsons or AIG's Maurice Greenberg, few Americans can name even one single banker.
But that is about to change.
As a result of this month's most recent eye-popping merger of JPMorgan Chase with Chicago's Bank One, the U.S. banking industry once again has a leader in the Rockefeller-Clausen-Wriston mold.
Jamie Dimon is a 47-year-old, smart, loud, demanding, and fearless Queens, New York native, who in less than two years will be known to all as the world's most dominant banker.
Fired by his mentor of 16 years, Sandy Weil at Citigroup, the Wall Street-hardened/Harvard Business School-educated Dimon joined Chicago's troubled Bank One in early 2000, with the company suffocating from out-of-control expenses and looming loan losses.
Since that time, Dimon has, as he himself put it, "chain sawed" the Midwest bank's expenses by a whopping $1.8 billion, reduced the Bank One workforce by thousands of people, deftly navigated the institution through large nonperforming loans, and recruited a handful of loyal and talented lieutenants to help him succeed. From a loss of $511 million in 2000, annual earnings at Bank One now total $3 billion.
Dimon, in other words, has turned the bank around, presided over a 34% increase in the stock price, and, as a consequence, become the banking darling of Wall Street.
Moreover, and not inconsequential in the days of Enron and Worldcom and Tyco, Dimon achieved his dramatic turnaround by imposing impeccable ethical standards. According to anyone with whom he has worked, Dimon is intolerant -- to the point of going instantly ballistic -- of any shenanigans in structuring deals, honoring commitments, or producing balance sheets and income statements.
"Jamie Dimon," said Arthur Levitt, who as SEC chairman preceded Elliot Spitzer in his zeal to root out financial wrongdoers, "is the un-Enron."
Or, as Dimon himself has put it,
"Most people have plenty of brains to succeed in business. The difference is character. Leadership is a privilege and a responsibility and an honor. Leaders are the people who should work the hardest, not the least. "
And now -- or technically, two years from now, when JP Morgan Chase CEO William Harrison turns over the reins -- Jamie Dimon steps onto the world stage.
In so doing, Dimon -- much more than his two competent but low key primary rivals, Ken Lewis of Bank of America and Charles Prince of Citigroup -- assumes the mantle of David Rockefeller and Walter Wriston.
Some years ago, Rockefeller, assessing the landscape of silent and secretive and sometimes crooked CEOs, told the New York Economic Club,
"Business leaders must recognize their own and their companies' broader role in the public dialogue….to dispel the notion that corporate executives are faceless bureaucrats, interested only in furthering selfish ends and insensitive to the wider concerns of society."
Mr. Rockefeller will be pleased to learn that his beloved banking industry and his cherished Chase alma mater will soon no longer be "faceless."
The "face" of banking is about to become that of a brash and brilliant, not-yet-50-year-old New Yorker, who works hard, plays fair and takes no prisoners.
Fraser P. Seitel, managing partner of Emerald Partners communications consultancy, served as public affairs director of The Chase Manhattan Bank for 10 years, under three CEOs, Thomas Labrecque, Willard Butcher and David Rockefeller.
http://www.techcentralstation.com/012704B.html
The gradual collapse of the dollar..shorting it...
Don't believe a single statistic the US government publishes...its all manipulative lies!
President Bush's goal of halving this year's projected $500 billion deficit by 2009 distracts from the more serious crunch the government faces later as the huge baby boom generation ages, critics say.
"Is it achievable? Yes," said Robert Reischauer, former head of the nonpartisan Congressional Budget Office (search) who is now president of the Urban Institute (search). "Is it likely to occur? No. Is it sustainable? Probably not, because the world turns worse" at the end of this decade. That is when the 76 million baby boomers will begin drawing on Medicare and other costly income support programs, likely pushing federal deficits ever higher.
Administration officials say they want a deficit in 2009 that is half of this year's level, which White House budget chief Joshua Bolten (search) has said he expects to hit $500 billion.
Achieving a $250 billion deficit in five years, however, could take hundreds of billions in savings, a difficult political task.
Bush will seek to cut the deficit in his $2.3 trillion budget request for 2005. He will send it to Congress in February, nine months from the presidential and congressional elections.
White House officials deny talk on Capitol Hill that they might define their goal as halving the deficit's percentage share of the U.S. economy in five years. This year's $500 billion deficit represents 4.4 percent of the economy. That would make their target 2009 deficit 2.2 percent of that year's economy, or about $320 billion, leaving their task $70 billion easier.
When the budget year ended Sept. 30, the deficit was $374 billion, the highest ever in dollar terms. Administration officials say a more important measure is how the shortfall compares with the size of economy, with last year's 3.5 percent share far below the 6 percent post-World War II peak of 1983.
"We can cut the deficit in half by 2009 by any number of standards, though we feel the deficit as a percentage of" the economy "is the most economically relevant measure," said White House budget office spokesman Chad Kolton.
White House officials say Bush will rely chiefly on two strategies. He will propose extending tax cuts that would otherwise expire, which they say will spur the economy, and seek to limit the growth of spending that Congress must approve each year, probably to 4 percent or less.
"We're working with Congress to hold the line on spending," Bush said Monday. "And we do have a plan to cut the deficit in half."
The goal is backed by many Republicans, at least as a starting point. But conservatives want a bolder move against the record deficits and big spending increases that the administration has run up.
"It's a rather anemic goal, actually," said Stephen Moore, president of the Club for Growth (search). "We should be talking about how to balance the budget."
Democrats say that even if Bush achieves his objective, he would leave huge shortfalls because he has driven deficits so high. Bush took office when large surpluses were projected for the foreseeable future. But the forecast has since been dashed by recession, the costs of fighting terrorism and wars, and tax cuts.
"Now that they've created the biggest deficits in American history, they say we'll have half a hole rather than a full hole, and they want credit for a victory," said Thomas Kahn, Democratic staff director of the House Budget Committee.
A $250 billion deficit would be the fifth highest on record in dollar terms. A $320 billion shortfall would be the second worst.
With projections that the economy will strengthen, deficits are expected to gradually improve after this year.
The Congressional Budget Office projected in August that after peaking at $480 billion this year, the gap would drop to $170 billion by 2009 - if new tax cuts are enacted and spending grows only at the rate of inflation.
Those assumptions already have proved false. Since August, Congress has expanded Medicare, creating prescription drug coverage and (search) improvements in veterans' benefits. They are expected to add $52 billion to the deficit in 2009.
Other costly proposals in the works include Bush's plan to extend expiring tax cuts; a revision of the alternative minimum tax to prevent middle-income earners from paying it; and energy legislation already passed by the House.
If, along with those items, spending controlled by Congress grows at the average 7.7 percent annual rate seen since 1998, the resulting 2009 deficit would be $666 billion, G. William Hoagland, budget aide to Senate Majority Leader Bill Frist, R-Tenn., warned senators in a recent memo.
That would mean $416 billion in budget savings would be needed to reduce that year's red ink to $250 billion.
If congressionally approved spending grows only at the rate of inflation, the 2009 deficit would be $432 billion, Hoagland wrote.
Lawmakers have shown little taste for such a small increase. If they did - and that would mean no unforeseen expenses like new wars - it would still require $182 billion in 2009 savings.
Acknowledged House Budget Committee Chairman Jim Nussle, R-Iowa, who supports Bush's goal, "It's not an easy lift."
http://www.foxnews.com/story/0,2933,106122,00.html
http://www.foxnews.com/story/0,2933,106122,00.html
None of them rallied today.
Pennny
I don't see how the $ even rallies like it is with those kind of deficits--Peaceb2u
US federal deficit to rise by extra $986bn
By Christopher Swann in Washington
The US budget deficit is likely to be almost $1,000bn larger over the next decade than previously projected, according to the new official congressional forecast released on Monday.
Economists said the new estimates from the Congressional Budget Office, the non-partisan agency of Congress, suggested President George W. Bush would struggle to meet his administration's pledge to halve the deficit over the next five years.
The CBO predict a cumulative deficit of $2,350bn between 2004 to 2013 - $986bn more than it forecast just six months ago.
The projections underscore the dramatic deterioration in the US budget position under the Bush administration. Democrats, who have been making great play of the administration's lack of fiscal restraint, seized on the figures to step up their attacks on the White House.
John Spratt, a Democratic member of the House budget committee, said the deficit was now reaching alarming proportions. "While Republicans suggest that these record-breaking deficits are 'manageable', there is growing awareness of the dangers these deficits pose to the economy," he said.
"Chronic deficits crowd out private investment, push up interest rates, and slow down economic growth. The specter of large and uncontrolled budget deficits could cause dramatic dislocations in financial markets."
Of the deterioration in the 10-year outlook since the CBO's previous forecasts last August, $681bn is due to legislation enacted by Congress last year. This includes a $400bn plan to add a prescription drug benefit to Medicare, the federal health programme for the elderly, and add to incentives to private insurers to participate in the programme.
The CBO is also assuming that lower inflation will eat into federal revenues and that even strong economic growth will produce more modest tax revenues than in the late 1990s.
Analysts warned that the fiscal outlook could be even more gloomy than the CBO's headline forecast.
Under its rules, the CBO assumes that discretionary spending will rise by little more than the rate of inflation, falling as a share of gross domestic product.
The CBO's analysis shows that if other administration pledges were included, the deficits would be even larger. That in turn would defeat the administration's target of halving the deficit in the next five years.
Mr Bush has pledged that a series of tax cuts enacted by his administration, which had been due to expire, would be made permanent. The Bush administration has also said it will reform an obscure part of the tax code called the alternative minimum tax to prevent it affecting middle-class taxpayers.
Many economists are sceptical that the administration will be able to keep discretionary spending increases under control over coming years.
http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=107...
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Japan's life-insurance industry reportably holds 25% of the U.S. 12 trillion dollars in household savings.
As highlighted by the failure of Nissan Mutual Life Insurance Co., his industry is also in need of a life line. When Nissan Mutual collapsed, liabilities exceeded assets to such a degree that the industry's entire 200 billion yen emergency reserve covered only 2/3 of the loss. These company's have promised returns as much as 5.5% while earning only 2.9% on investments in 1996. For 1997, with bond interest rates decreasing and the stock market declining, returns on investment will likely fall below 1996 levels. According to Standard & Poor's, the level at which hidden profits on stock holdings disappear are as follows:
http://www.gold-eagle.com/gold_digest/kutyn111597.html
Currency vacuum
There is a gaping hole at the centre of the G7's plan to prevent a recurrence of the recent financial crisis
Frequent repetition of a financial crisis on the present scale would be quite intolerable. So even though they are still trying to put out the fire, policymakers must also do their best to prevent another conflagration.
To their credit, the finance ministers and central bank governors of the Group of Seven leading industrial countries made a serious attempt last week. Their declaration reflected the efforts of Gordon Brown, chairman of the G7 finance ministers this year, and built upon three reports from the Group of 22 "systemically significant economies".
The resulting agenda is sensible. It includes increasing the transparency and openness of the international financial system; enhancing stability, particularly through more effective regulation; and improving ways to respond to crises, particularly through orderly workout arrangements, better insolvency regimes and lending into arrears by the International Monetary Fund. Nevertheless, the recommendations seem both too ambitious and not ambitious enough: they contain a dauntingly wide range of complex and intractable reforms, but they still do not tackle a central question, that of exchange rate regimes.
The questions raised by global financial instability are as many and interwoven as the Gordian knot; leaders must cut through it. The sharpest sword they have is advice on exchange rates. Emerging markets should be encouraged to adopt either of two extremes - either fairly freely floating regimes or robust currency boards, which fix a currency to an anchor, usually the dollar.
Yet all the G7 declaration calls for is "consideration of the elements necessary for the maintenance of sustainable exchange rate regimes in emerging markets, including consistent macroeconomic policies". Even in the G22 report on crisis prevention and management, less than two pages of the 42 are devoted to exchange rate regimes. This is Hamlet without the prince.
Exchange rate regimes matter. To understand why, one must start with the frightening number of banking crises and no less impressive number of currency crises over the last two decades. Bad though these are when separate, maximum devastation occurs when they arrive together, as happened in Chile in the early 1980s, Mexico in the mid-1990s and Thailand, Indonesia and South Korea last year.
The fiscal costs of such banking crises can range from 20 per cent to 40 per cent of gross domestic product. But a currency crisis imposes the additional trauma of a forced external adjustment. Even the IMF's relatively optimistic forecasts suggests that the four most affected Asian economies will regain 1997 levels of GDP only by 2001. Four lost years must be the least bad outcome to be expected.
Contrast that with Japan today or the UK in 1992. Japan has a banking crisis, but there is no constraint on its ability to provide cheap money and fiscal expansion at home. Britain suffered a currency crisis, but devaluation allowed lower interest rates and a swift return to growth. Neither has suffered anything like the trauma of the crisis-hit emerging countries.
The explanation is that the UK and Japan had no significant foreign-currency debt. Large quantities of foreign currency debt, unmatched by foreign currency assets of equivalent size and maturity, guarantee that a currency crisis will cause a banking collapse, and vice versa. Once the exchange rate falls, borrowers, particularly banks, will find their liabilities rising in value against their assets. Similarly, if the financial system begins to look infirm, foreign creditors will take their money out, thereby creating a currency crisis.
There is also a close connection between the size of foreign currency debt, exchange rate regimes and a currency crisis. That connection is a fixed exchange rate. Suppose the authorities have kept their currency pegged to an anchor over a lengthy period. Naturally, some borrowers treat borrowing in foreign currency as no different from borrowing in domestic currency. Similarly, some lenders begin to think their investments are protected against exchange risk.
This is a recipe for huge capital inflows and large current account deficits. Should the government wish to limit the expansionary effects on domestic credit, by raising domestic interest rates, the incentive to borrow in foreign currency will increase. As foreign debt piles up, domestic credit expands and the economy overheats. A crisis of confidence becomes inevitable and the country finds itself buried under the rubble of banking and currency collapses.
There are three ways for a country to minimise the danger: regulatory, prudential and market-based. The regulatory solution is to create a healthy and well-capitalised banking system, while curbing foreign currency mismatches and perhaps imposing permanent curbs or taxes on debt-creating inflows of foreign currency. The prudential solution is to accumulate sizeable foreign exchange reserves or contingent lines of foreign credit. The market solution is a floating exchange rate.
With a floating exchange rate, foreign currency risk is an abiding presence. Floating rates economise on what emerging markets lack - honest, effective and public-spirited regulation. Regulation will still be needed, but its defects should be less disastrous.
Floating exchange rates also economise on international lender-of-last resort facilities. Indeed, the principal G7 suggestion for dealing with contagion, the "contingent short-term line of credit" is, in practice, largely needed to stabilise pegged exchange rate regimes, such as that now in Brazil. Under floating exchange rates, external funds may still occasionally be required to halt collapses in the rate, but these are likely to be more infrequent and less dramatic than when an established peg is broken.
The G7's silence on exchange rate regimes is understandable, since the topic is so controversial. But it is a mistake. The choices should be debated now.
First, countries can continue to operate adjustable-peg or other tightly managed regimes, but they will then need tough regulation of the financial system and, in all probability, control over capital flows as well. There may also need to be large-scale contingent external assistance, in the form of funds available to prevent, cushion, or halt currency collapses.
Second, countries can adopt fully fixed exchange rates, such as Argentina's currency board. This can work, but it demands a liquidity policy for both the banking system and the country, with large reserves, not just to back narrow money, but to support the banking system through panic. Flexible nominal prices and wages will be needed. So may external contingency funds. There are valid arguments for choosing this option: the country may feel politically unable to develop a credible, domestic monetary regime; alternatively, it may fear the destabilising fluctuations in real exchange rates that accompany a float. But it remains a huge gamble.
Finally, countries can float. Some of the need for regulation under adjustable pegs will then be taken care of automatically, via market forces. True, floating rates may also demand foreign currency support in a world crisis, but less than if a peg is to be defended. Floating exchange rates are the worst possible system - except for all the others.
Martin.Wolf@FT.com
http://www.geocities.com/Eureka/Concourse/8751/versib/ft1104.htm
http://econ-www.mit.edu/faculty/jaume/files/LICC.pdf
Confidence in the Indonesian currency, the rupiah,
has continued to fall for a fourth day in succession, pushing it down to a record low level of more than 10,000 to the US dollar.
Currency traders said the lack of response from the government to the economic crisis, together with reports that the International Monetary Fund might reconsider its aid package to Indonesia, were frightening investors away.
A growing number of Indonesian companies are closing down, with the loss of thousands of jobs. The official trade union estimates that close to 10 million people will be come unemployed this year. Our Jakarta correspondent Jonathon Head reports:
The Indonesian currency is falling out of control with no end in sight. It's worth less than a quarter of its value six months ago.
Currency traders say anyone holding large amounts of rupiah is now trying to convert them to dollars as quickly as possible in case of further drops in value. The collapse of the currency has begun to affect Indonesians across the social spectrum.
There are no established bankruptcy procedures, but hundreds of businesses, overwhelmed by their dollar debts and a drop in orders, are reported to have closed down. The authorities say at least two million people have already lost their jobs.
The officially sanctioned trade union predicts that the total of unemployed workers will reach 10 million this year. Pawnbrokers in Jakarta say the number of customers seeking emergency loans has gone up sharply, and some shops are now reporting a sudden increase in business, as middle-class Indonesians rush to spend their money before it loses more of its value.
The greatest immediate concern for the authorities is the rapid rise in food prices, which is hurting poorer Indonesians. The armed forces says it is making special preparations to deal with outbreaks of social unrest.
But there's still no sign of any concerted action by the government to try to tackle the economic crisis. Some analysts believe President Suharto is no longer capable of making the tough decisions needed to restore confidence.
One leading Indonesian economist described the situation as a disaster.
My heart is burning, he said, but what can I do when we have no leadership?
http://news.bbc.co.uk/1/hi/despatches/45644.stm
http://www.itam.mx/lames/papers/contrses/jagonzal.pdf
Currency Collapses
5th November 2002
Harare - Zimbabwe could face economic meltdown this year unless its government acts to end the economic crisis that has seen the country's currency collapse in the last fortnight, according to the International Monetary Fund (IMF).
Just two weeks ago Zimbabweans were paying Z$750 for an American dollar on the black market. On Monday, after a fortnight of freefall, a staggering Z$1 600 was needed to buy US$1 - and it is expected that the beleagured currency will fall further.
Meanwhile, the IMF has predicted that inflation could rise to 522 percent next year. IMF country representative in Zimbabwe Gerry Johnson said on Monday: "You're moving into a situation where it could go much higher than that. Once you get to that point, it can go very fast."
With prices rising daily, businesses selling imported goods have stopped advertising prices. One computer company's adverts simply say "$ Call next to items for sale".
Beef prices rose 100 percent overnight And in supermarkets the price of imported goods like butter last week doubled, reflecting the fall of the Zimbabwe dollar against the rand.
Zimbabweans now pay up to Z$160 for R1 as foreign currency-starved businesses clamour for anything they can get.
And it's not just imported goods that double in price. On Monday beef prices rose 100 percent overnight, anticipating a shortage caused by the slaughter of three-quarters of Zimbabwe's commercial beef herd.
The slaughter, forced by the eviction of thousands of white farmers, will turn Zimbabwe from the region's most famous beef exporter into a net importer of beef within a year, say industry insiders.
Movement for Democratic Change economic affairs spokesperson Eddie Cross said the meltdown had been "engineered by the ruling Zanu-PF party".
"In 22 years, the life expectancy of our people has declined 22 years on average. We have gone from being a net exporter of food to being dependent on imports for 75 percent of what we need to survive."
http://rhodesian.server101.com/currency_collapses.htm
Factors Driving the Dollar Down Down Down till November
One of the most important factors would certainly be interest rates. With the US economy struggling since 2001, the Federal Reserve – the central bank regulating the US dollar – has repeatedly cut interest rates, hoping to increase borrowing and thus stimulate the economy. The table below documents the fall of US interest rates. While ECB rates were cut repeatedly during this time as well, the overnight rate on the euro remained higher than the US dollar throughout the period in reference.
The series of rapid interest rate cuts made by the Federal Reserve really manifested themselves in the US dollar’s valuation during the course of the first half of 2002. After the barrage of rate cuts ending on December 11, 2001, the euro-US dollar exchange rate soared, reaching approximately .9975 by the beginning of July 2002. This marked an increase of approximately 12.26% from its December value of .8885. Clearly, the rapid series of interest rate cuts had left their mark.
Of course, while interest rates certainly may have played a key part in the dollar’s descent, they were not the only factor.
Another parallel to the dollar’s drop off would be the unemployment rate. The US economy had experienced the bursting of the dot-com bubble, thus leaving legions of its work force unemployed. As a result, the US unemployment numbers continued to rise – thus creating a spiral of economic weakness that helped to create a weaker US dollar.
Another extremely powerful albeit unquantifiable factor that dictates the market value of a currency is geopolitical events.
Perhaps the most influential factor that determined the fall of the dollar and the rise of the euro, though, were the key geopolitical events that have occurred early in the new millennium. Consider the following timeline:
September 2001 – The devastating attack on the World Trade Center in the United States ushers in a new era: trading volume on the US stock exchanges diminishes rapidly, and investors begin to take their money out of the US due to the threat of terrorism.
January 2002 – Euro notes now come into existence; they will be used in conjunction with the decreasing number of national currency notes.
January 2002 – Public administration, banks, and financial companies must now complete all transactions in euros.
July 2002 – National currencies lose their legal status; the changeover to the euro is essentially complete.
November 2002 – US President Bush begins his push to have UN weapons inspectors enter Iraq to search for weapons of mass destruction. In the United States, the US’ Department of Homeland Security begins to take a more proactive stance.
February 2003 – The US goes before the United Nations to support their initiative to enter Iraq. The threat of terrorism in the US continues to rise, and investor uncertainty mounts as a result.
March 2003 – In spite of UN disapproval, the US enters Iraq. Military conflict begins.
Clearly, changes in the economies of both the Eurozone and the US, as well as several vital geopolitical events, drastically altered the values of both the euro and the US dollar. Through the FX market, individuals could have seized the trading opportunities resulting from exchange rate movement
Summing It All Up
Put together, US Federal Reserve interest rate cuts, rising unemployment, and ongoing geopolitical events have combined to create a 43% rise in the euro’s value against the dollar. Traders who had considered larger, macroeconomic factors and implemented their analysis by purchasing the EUR/USD currency pair in the FX market would have had the potential to earn substantial profits.
The global currency market trades $1.5 Trillion per day, making it the largest, most liquid market in the world. The market's size and structure provide traders with advantages not available through other markets.
http://www.fxcmmini.com/live_prices.html
http://www.dailyfx.com/FinanceChart.html
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