Up and Down Wall Street

WEDNESDAY, SEPTEMBER 29, 2010

The World Wakes Up to Threat of Currency Wars

By RANDALL W. FORSYTH

CALL IT "CURRENCY WARS" or a "race to the bottom," the threat of competitive devaluations by governments to gain an advantage in a world of weak demand and high unemployment suddenly has come to the fore.


It is a threat I addressed here almost two weeks ago ("Central Banks Embrace Risky Currency Gambit," Sept. 17.) In a world where major central banks have slashed short-term interest rates—their traditional policy lever—to nearly nil, they are increasingly turning to their other, rarely used option, currency devaluation.


Now, the specter of international currency wars has been raised by Guido Mantega, Brazil's finance minister. "We're in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness," the Financial Times quoted him as saying. In that, the FT asserted Mantega was saying out loud what policy makers were saying in private (not to mention what was being written in this space.) No doubt this will be a major topic of discussion at next week's annual meeting of the International Monetary Fund and World Bank in Washington.


As noted here, these moves to keep a lid on currencies recall the "beggar thy neighbor" policies of the 1930s, which helped to spread and deepen the Great Depression internationally. Indeed, one especially perspicacious reader of this column suggests that this currency race to the bottom effectively constitutes "Smoot-Hawley Redux." Aren't governments now using currencies doing the same thing as the infamous tariff passed in 1929, which contributed greatly to the Great Depression?


The point is well taken. Mantega's government has been contending with relentless upward pressure on the Brazilian real as exports boom, especially to China. Meanwhile, global capital floods into the Brazilian capital market, which offers yields of 12% on government bonds denominated in an appreciating currency, the result of a tight monetary policy to restrain inflation.


Meanwhile, central banks and governments in the developed world are desperately fighting the economic stagnation and deflationary pressures resulting from the credit bubble and bust of the past decade. As noted, the key weapon has been to cut short-term interest rates to an irreducible minimum, along with emergency measures in the U.S., U.K. and Europe to prop up their financial systems. Then came outright buying of bonds by central banks, including $1.7 trillion by the Federal Reserve, to help push down longer-term rates.


The measures taken during the dark days of the crisis in late 2008 and early 2009 were remarkable for the coordination among policy makers across borders. Importantly, it was recognized that the crisis was international in nature, not the least because of the reckless purchase of securities backed by rotten American mortgages transcended borders. Toxic U.S. mortgages infected investments from Asia and Australia to Europe as well as their home market. The U.K., meanwhile, suffered a housing collapse that in many ways was a mirror image to the U.S., if not magnified.


That coordination has given way to competition. Two weeks ago, the Bank of Japan reportedly intervened to purchase the equivalent of ¥2 trillion ($23 billion), its first foray into the currency market since 2003. Importantly, the Japanese central bank left that ¥2 trillion in the domestic money market, instead of draining—or "sterilizing"--the liquidity injection from the forex operation.


What's noteworthy is that the BOJ intervention probably was rooted as much, if not more, in politics than economics. The operation followed the resolution of a fight for leadership in Japan's ruling party, a major point of contention was the soaring value of the yen, which is becoming a major factor in further depressing the nation's economy after what is dragging on to a second lost decade. While the challenge of the insurgents (who had wanted more forceful action to push down the yen) was defeated, the message wasn't lost on the incumbents. They quickly dispatched ¥2 trillion—which initially pushed dollar to 85 yen from 83 yen, but the effect has dissipated and the dollar is back under 84 yen. Which is to say, the BOJ has done squat.


Meanwhile, the euro has soared, from under $1.20 around mid-year and $1.27 as recently as Labor Day, all the way back to $1.35. That's about the last thing the eurozone economy needs. A salutary side-effect of the European sovereign debt crisis was a weakening of the euro, which goosed Germany's export-oriented economy to a nearly 9% annualized growth rate in the second quarter. With the euro's appreciation since then, growth has slowed markedly. And economies that produce little in the way of tradeable goods failed to see any benefit, such as tourism-dependent Greece. As spectacular as the sunsets are in Santorini, I'm not going there if there's a chance I'll be stuck in Athens airport by a strike against austerity—regardless of the exchange rate.


And, of course, the elephant in the room is China. As crucial U.S. midterm elections approach and the domestic economy continues to flag, the potential for retaliatory actions against the perceived undervaluation of the renminbi looms. While Chinese officials rightly point to the negative potential for the dollar from the rising U.S. government debt burden, U.S. officials contend China artificially suppress its currency's value. How? By financing the U.S. fiscal deficit by purchasing Treasuries, although China has pared its holdings of U.S. government obligations in recent months.


The downward pressure on the dollar is exacerbated by Fed's efforts, which it articulated last week as aiming to raise the inflation rate, which it said had fallen too low to meet its other goal of higher employment. Exports will be a major part of that effort, especially in view of President Obama's goal to double sales abroad.


All of which makes a strong currency undesirable to countries around the globe looking to do likewise. In a world where the pie isn't growing, everybody's looking for a bigger slice. But that's not possible for everybody and indeed becomes counterproductive as barriers are erected to trade.


That is why there are no winners in currency wars, only losers, which is the lesson of the 1930s. Most of the other lessons of that era have been learned well; policy makers have tried to counter the debt-deflation spiral that strangled economies then.


The question is whether they will heed the perils of competitive devaluations. So far, the signs aren't encouraging, which may help explain why gold surged to a record over $1300 an ounce.


Copyright 2010 Dow Jones & Company, Inc. All Rights Reserved

WONDER LAND

SEPTEMBER 30, 2010.

The Only Policy Left: Growth

The GOP needs leaders willing to do what's necessary to get it.

By DANIEL HENNINGER

With the November election just around the corner, President Obama spent the past two days hanging in middle-class folks' backyards in Albuquerque, Des Moines and Richmond to discuss the state of the economy. But it could be the American people are pretty well talked out on the economy. Rather than talk, it looks as if they are about to repudiate a formerly popular president who has disappointed them, throw over a Democratic Party they think has failed them, and hand power to a Republican Party they don't trust.


Let's see if we can offer a snapshot of the national mood just now. Fast-forward toward the end of "National Lampoon's Christmas Vacation," after Clark Griswold discovers that his holiday bonus is a subscription to the Jelly of the Month Club. Ripping the envelope to shreds, Clark describes what I would call the American people's current, bipartisan view of their political leadership: a "cheap, lying, no good, rotten, four-flushing, low-life, snake-licking, dirt-eating, inbred, overstuffed, ignorant, bloodsucking, dog-kissing, brainless, hopeless, heartless . . . worm-headed sack of monkey bleep!"


A more circumspect version of this view came recently from no less than Federal Reserve Chairman Ben Bernanke, speaking at this summer's gathering of the world's financial elites in Jackson Hole: "Central bankers alone cannot solve the world's economic problems."


Translation: Nothing the politicians have done works, and all we're left with is a worm-headed sack of monkey bleep. Now what?


We have an unemployment rate that is beginning to look stickily stuck above 9%. GDP growth, the official measure of economic life, keeps falling (down to 1.6% in the second quarter). The stock index blips up and down daily.


Solution No. 1 was to throw nearly $1 trillion of stimulus at the economy. But Keynes failed. Then they sprayed the economy with gallons of Chairman Ben's Quantitative Elixir, or QE. Nothing happened. They could have extended the Bush tax cuts, but instead the Pelosi Democrats punted the subject past the November election, the equivalent of kicking the ball straight up in the air.


It looks to me as if there's only one policy they haven't tried: economic growth.


Economists dispute among themselves about a lot, but not about the proven wonders of strong economic growth. It creates jobs, increases individual wealth, reduces debt, and enhances national well-being. Strong, as opposed to the middling, economic growth the U.S. has now, is so vital that a great nation should want to do whatever it takes to get it.

Brazil Crops Shrivel as Amazon Dries Up to Lowest in 47 Years

By Lucia Kassai

Sep 24, 2010 1:21 PM ET


Drought in Brazil, the world’s biggest producer of coffee, sugar and oranges, is harming crops and drying the Amazon River to its lowest in 47 years.


The Amazon’s 18-meter (59-feet) level on Sept. 20 was the least since 1963, disrupting transportation of food, fuel and medicines in northern Brazil, the National Water Agency said in an e-mailed statement. Growers in Brazil’s Southeast expect the drought will pare output of the nation’s key commodities.


Sugar rose to the highest price in seven months in New York today and has jumped 29 percent this month because of concern the South American drought threatens global supplies. Orange juice gained 15 percent this month and coffee soared 33 percent this year. The dry weather will persist at least until mid- October, said Willians Bini, a meteorologist at Sao Paulo-based weather forecaster Somar Meteorologia.


“Farmers will have to be really patient because rains are delayed for at least a month,” Bini said in a Sept. 20 telephone interview.


La Nina, as the cyclical cooling of equatorial Pacific Ocean waters is known, triggers changes in weather across the globe, including dryness in parts of Brazil and hurricanes in the Atlantic Ocean.


Coffee crops in the southeastern state of Minas Gerais may be hurt by the driest weather in four years as Spring starts in the Southern Hemisphere and trees begin flowering for next year’s harvest, Joaquim Goulart de Andrade, a manager at the Cooxupe cooperative, said in a telephone interview last week. The group produces 13 percent of all Brazilian arabica coffee. Minas Gerais accounts for about half of the country’s output.


‘Disaster’


Rainfall in Cooxupe’s region averaged 85.2 millimeters (3.35 inches) in the five months through August, the least since 2006 and less than half the 49-year average of 212.3 millimeters for the period, according to data on the cooperative’s website.


“If it doesn’t rain, there is just one word to describe it: Disaster,” Aldir Alves Teixeira, who manages coffee purchases in Brazil at Illycaffe SpA, said in a telephone interview from Sao Paulo last week.


Trieste-based Illycaffe is Italy’s biggest roaster after Lavazza SpA and buys half of all its coffee from about 1,200 growers in Brazil.


Sugar-cane crops in the Brazilian Center South, the world’s largest producing region, are also being hurt by a drought that will pare yields for this harvest and the next, Jacyr Costa Filho of sugar maker Acucar Guarani said in a Sept. 20 telephone interview from Sao Paulo.


‘Serious Damage’


“Yields have already been seriously damaged,” said Costa, chief executive officer of the sugar maker controlled by Tereos, Europe’s third-largest sugar producer. “The losses are already there.”


Sugar-cane output may fall for the first time in 11 years in 2011, said Gustavo Correa, an analyst at research firm FG/Agro in Ribeirao Preto, a sugar and ethanol industry hub in northern Sao Paulo state.


“The weather is also harming seedlings, reducing output potential for coming crops,” Correa said in a Sept. 17 telephone interview.


The Center South will harvest between 530 million and 560 million metric tons of sugar cane next season, down from about 570 million tons this year, he said. The last time production fell was in 2000, according to data on sugar industry association Unica’s website.


At Brazil’s main sugar ports, showers from cold fronts that have cleared up at the coast before reaching rural areas are delaying ship loading because humidity harms the product.


Drying Groves


Orange groves in Brazil’s citrus belt, the world’s biggest producing region, will reduce output more than previously expected this year to the lowest since 2001 because of below- average rain, according to Sucocitrico Cutrale Ltda., which makes about 30 percent of global orange-juice supplies.


The region’s orange crop may drop to 271.7 million boxes, less than a May 7 estimate of 286 million, Cutrale Corporate Affairs Director Carlos Viacava said in an interview last week. Production will decline from 305 million boxes last year. A box of oranges weighs 90 pounds (40.8 kilograms).


“Dryness is so extreme in the fields that sometimes it is even hard to breathe,” Viacava said.


Cutrale, the world’s second-biggest orange-juice producer, owns groves and processing plants in Sao Paulo and Florida and port terminals in Brazil, Europe and Asia. The company, based in Araraquara, Brazil, supplies orange juice to McDonald’s Corp. and Coca-Cola Co.’s Minute Maid. A joint venture between Brazil’s Citrovita and Citrosuco is the world’s largest producer.


Planting Delays


Soybean farmers in Brazil, the world’s biggest producer after the U.S., are delaying planting for the next crop as they wait for rains in center-western Brazil, Somar’s Bini said. Planting in Mato Grosso state, which produces about 30 percent of the country’s soybeans, usually starts in mid-September.


Soybean futures have risen 11 percent in Chicago this month on concern dryness in Brazil and Argentina may delay planting and reduce sowing of the oilseed.

A recipe for trouble in China’s backyard

By David Pilling

Published: September 29 2010 19:58

Take a handful of uninhabited islets roughly equidistant between Okinawa and Taiwan. Add a Chinese trawler captain, determined to fish in what he regards as Chinese waters. Then mix in a Japanese patrol boat defending Tokyo’s control of the islands. Finally, leave the Chinese fisherman to stew (preferably in a non-stick Japanese jail) for two weeks. Voilà. You have just created a diplomatic row to traumatise much of Asia and rattle even Washington.


The immediate cause of alarm is Beijing’s rough-house tactics following the captain’s arrest in waters near the disputed Senkaku islands, known as Diaoyu islands in Chinese. Not only did Beijing insist on the captain’s immediate release, a demand to which Tokyo eventually capitulated. It also escalated the dispute. It arrested four Japanese nationals; blocked exports of rare earths used by Japanese electronics companies; cancelled diplomatic exchanges; and allowed anti-Japanese demonstrators to pour on to Chinese streets. (It even canned the tour of SMAP, a Japanese boy-band.) Even the release of the captain did not mollify Beijing, which demanded an apology and compensation.


The underlying concerns go deeper still. Diplomats detect a pattern of more assertive – some say aggressive – Chinese behaviour. If Japan, with its still-powerful economy and sophisticated defence force, cannot stand up to Beijing, what hope for the many smaller countries that have territorial disputes with China? Most of these have lain dormant for decades. Beijing has hitherto been happy to put them on the back-burner, favouring a charm offensive aimed at convincing neighbours that its rise poses no threat.


Those days may be over. Beijing has begun to pursue its regional interests more forcefully. Its navy has conducted boisterous war games. Its government has warned off western companies, including Exxon Mobil, from doing business with Vietnam in waters that China also claims. Retired generals have started referring to the South China Sea – a body of water The Economist calls a “great lolling tongue of Chinese sovereignty” – as a core interest.


Although not yet official terminology, this raises the prospect of Beijing putting the South China Sea, with its shipping lanes stretching to the Malacca Straits, on a par with Tibet and Taiwan. That would make the sovereignty issue non-negotiable, a problem for the several nations, including Vietnam, the Philippines, Indonesia, Malaysia, Singapore and Brunei, that have overlapping claims. It would be akin to a Chinese Monroe Doctrine, which asserted the rights of a then-rising US to its Latin American backyard.


These signs of Chinese swagger have provoked panic in some quarters. Shintaro Ishihara, the admittedly mouth-frothing Tokyo governor, compared China to a crime outfit expanding its turf. Chris Nelson, editor of a Washington newsletter, coined the ungainly (but useful) term “Putinizing”. Like Russia under Vladimir Putin, he said, China was playing to domestic nationalism by hardening previously friendly attitudes to its neighbours. Denny Roy, senior fellow at Hawaii university’s East-West Center, said China’s view of the Asia-Pacific ultimately “doesn’t have room for the degree of American influence we see today”. That could put the two sides on a “collision course”.


Part of the explanation for China’s harder tone may be a recent speech by Hillary Clinton, US secretary of state, in which she declared the South China Sea part of the US national interest and offered to mediate in territorial disputes. As well as pushing back against Washington, Beijing may believe it has outgrown Deng Xiaoping’s exhortation to “hide our capabilities and bide our time”. It may feel, in Mr Roy’s words, that now is the time to “push the system into a shape more to China’s liking”.


As China’s economic bandwagon rolls on, it is only natural – if not self-evidently desirable – for it to seek more regional influence. Since the US emerged as a great power last century, it has hardly been shy about pursuing its interests abroad. It built and controlled a canal in Panama, funded coups from Iran to Chile, and went to war in Indochina and the Middle East. To this day, its navy treats the Pacific as an American lake. By these standards, China’s ambitions for regional influence look decidedly modest.


The US has the advantage of being an attractive democracy with a dream to sell. That has been enough to win acceptance, if not always joyful embrace, of its extra-territorial activities. “There have been many question marks against US power, but it is the power we’re used to,” says Simon Tay, a Singaporean who has written about the loss of US influence in Asia. “The US is the foundation of the existing system.”


It is precisely the sense that Asia may be in transition towards a new power-sharing arrangement that is causing angst. China – a still-impoverished, authoritarian state – remains less trusted than the US in much of the region. No one really knows how Beijing would behave if it gained anything like the power Washington has so long enjoyed. That is why Asia looks so closely at incidents such as China’s diplomatic brawl with Japan – for clues as to what the future might hold.


Copyright The Financial Times Limited 2010.

Rethinking a Dollar-Heavy Asset Allocation

by: James Picerno

September 29, 2010

"Like it or not, significant dollar depreciation is more probable than most now suppose," writes Simon Johnson, a professor at MIT’s Sloan School of Management, in a Bloomberg column today. The market seems to be discounting no less. Certainly the gold market is roaring higher in part because the odds that the dollar will fall in the months (years?) ahead look quite a bit better than even.


Johnson, co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, sees three reasons why the dollar will trend lower: 1) worries over political gridlock in Washington as the country grapples with a huge budget deficit; 2) sluggish U.S. economic growth, which will compel the Fed to focus on lowering long-term interest rates, a.k.a., a new round of quantitative easing; and 3) the growing appetite of emerging market nations to diversify their large and growing foreign exchange reserves into currencies other than the greenback. "The dollar is, therefore, likely to depreciate against all floating currencies," Johnson predicts.


That's hardly a radical idea these days, considering that the buck has been more or less weakening since June. The previous rebound in the dollar that prevailed in the first half of this year now appears to be over. One reason is because of an increased appetite for risk in the global economy in recent months. When macro anxiety rises, liquidity tends to gravitate into dollars, the world's reserve currency. But as investors and governments have become convinced recently that the economic challenges aren't quite so acute, particularly outside of the developed economies, the appeal of non-dollar assets and currencies has taken flight once more. (Click to enlarge)