Markets Insight
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May 23, 2012 6:21 pm
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Bond exodus on a par with eurozone bank run

A great deal of attention is being heaped on the possibility of a bank run across the eurozone. But something just as important is currently happening: a bond run.



Foreign investors have left the government and corporate bond markets of Italy and Spain in droves in the past year and there is little evidence of the selling slowing down. If anything, the worry would be that the process carries on for some time as it has done in Greece, Ireland and Portugal.




There is little doubt that a generalised bank run across several countries would be disastrous. But so far there is scant evidence of it. Deposits at Italian banks have increased in recent months while those at Spanish banks have only dropped slightly.




But it is a different story when looking at foreign capital. JPMorgan analysts estimate €200bn of Italian government bonds and €80bn of Spanish bonds have been sold by foreign investors in the past nine months, more than 10 per cent of each market.



Matt King, a credit strategist at Citi, has gone further, peering into the detail of the infamous Target2 balances, which track cross-border payments in the eurozone. Much attention has focused on how Germany’s Target2 surplus has been increasing rapidly while peripheral eurozone countries’ deficits have soared.



Mr King takes balance of payment data from each country, which shows all cross-border capital flows, and subtracts Target2 and other public sector flows to show how much foreign capital flight there has been. The results are pretty frightening.



Spain has seen €100bn of outflows, about 10 per cent of GDP, since the middle of last year. Italy has been even worse affected – the latest figures show €230bn has flown out of the country in the same period, close to 15 per cent of output.




Much of the selling has been done under the cover of the European Central Bank’s cheap-loans programme for banks, known as longer-term refinancing operations. Foreign investors have used the thirst from domestic bondholders for local paper to get out.



Mr King estimates more is to come. Looking at the three bailed-out countries, Greece, Portugal and Ireland, he argues that capital flight is very hard to stop.


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Foreign bank deposits have fallen almost continuously in the past one to three years in all three countries, dropping 52 per cent on average from the peak. Foreign bond holdings have sunk by a third. “We estimate a further €200bn in flight from each of Spain and Italy is quite likely without further policy action,” he added in a report this week.



All this matters because Italy and Spain still represent big chunks of bond indices tracked by many investors. Indeed, because Italy has the third-largest bond market in the world it has accounted for more than 20 per cent of some government bond indices. Once risk managers spot that degree of concentration in an asset that is souring, more and more sell orders are likely.



And there are still plenty of assets to sell. JPMorgan estimates that, in Italy and Spain, foreign investors hold €800bn in government bonds, €500bn in corporate bonds and €300bn in shares. Throw in a collective €3tn of bank deposits, from everyone not just foreigners, and the potential for more pain in Italy and Spain is immense. Of course, selling by foreign investors may not matter for the countries if domestic investors can take up the slack. Japan offers the ultimate example of a country not reliant on foreigners to finance its sizeable deficit. But the speed of the selling matters – a trickle could be absorbed by domestic buying but the sort of outflows that Spain and Italy have seen recently are hard to cover if they carry on. Instead, as the Target2 balances show, the official sector has been taking the strain.



The euro project was meant to be different. It was designed to encourage cross-border capital and investment flows, not lead to nationalisation. The increasing worry is that aside from a few countries such as Germanyeurozone markets are becoming ghettoised, dominated by domestic investors who no longer invest as much outside their borders.



All this is without discussing the likelihood of a Greek exit from the euro or further default. One or the other seems increasingly likely from the markets’ point of view.



Contagion is hard to gauge but further selling from foreign investors at the least seems all but certain. More insidiously, a Greek default or exit, by crystallising losses for governments and central banks throughout the eurozone, could call into question their commitment to stand behind other troubled countries. Italian and Spanish borrowing costs now at premiums to Germany’s that are close to euro-era record levels – could spiral higher if investors worry about whether there is a backstop behind them.



A bank run may get the big headlines. But the run of foreign capital is potentially just as scary for the euro’s future.


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Copyright The Financial Times Limited 2012.

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Resilient China
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How strong is China’s economy?
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Despite a recent slowdown, the world’s second-biggest economy is more resilient than its critics think
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May 26th 2012
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CHINA’S weight in the global economy means that it commands the world’s attention. When its industrial production, house building and electricity output slow sharply, as they did in the year to April, the news weighs on global stockmarkets and commodity prices. When its central bank eases monetary policy, as it did this month, it creates almost as big a stir as a decision by America’s Federal Reserve. And when China’s prime minister, Wen Jiabao, stresses the need to maintain growth, as he did last weekend, his words carry more weight with the markets than similar homages to growth from Europe’s leaders. No previous industrial revolution has been so widely watched.






But rapid development can look messy close up, as our special report this week explains; and there is much that is going wrong with China’s economy. It is surprisingly inefficient, and it is not as fair as it should be.


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But outsiders’ principal concern—that its growth will collapse if it suffers a serious blow, such as the collapse of the euro—is not justified. For the moment, it is likely to prove more resilient than its detractors fear. Its difficulties, and they are considerable, will emerge later on.


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Outsiders tend to regard China as a paragon of export-led efficiency. But that is not the whole story. Investment spending on machinery, buildings and infrastructure accounted for over half of China’s growth last year; net exports contributed none of it. Too much of this investment is undertaken by state-owned enterprises (SOEs), which benefit from implicit subsidies, sheltered markets and politically encouraged loans. Examples of waste abound, from a ghost city on China’s northern steppe to decadent resorts on its southern shores.




China’s economic model is also unfair on its people. Regulated interest rates enable banks to rip off savers, by underpaying them for their deposits. Barriers to competition allow the SOEs to overcharge consumers for their products. China’s household-registration system denies equal access to public services for rural migrants, who work in the cities but are registered in the villages. Arbitrary land laws allow local governments to cheat farmers, by underpaying them for the agricultural plots they buy off them for development. And many of the proceeds end up in the pockets of officials.



This cronyism and profligacy leads critics to liken China to other fast-growing economies that subsequently suffered a spectacular downfall. One recent comparison is with the Asian tigers before their financial comeuppance in 1997-98. The tigers’ high investment rates powered growth for a while, but they also fostered a financial fragility that was cruelly exposed when exports slowed, investment faltered and foreign capital fled.


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Critics point out that not only is China investing at a faster rate than the tigers ever did, but its banks and other lenders have also been on an astonishing lending binge, with credit jumping from 122% of GDP in 2008 to 171% in 2010, as the government engineered a bout of “stimulus lending”.





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Yet the very unfairness of China’s system gives it an unusual resilience. Unlike the tigers, China relies very little on foreign borrowing. Its growth is financed from resources extracted from its own population, not from fickle foreigners free to flee, as happened in South-East Asia (and is happening again in parts of the euro zone). China’s saving rate, at 51% of GDP, is even higher than its investment rate. And the repressive state-dominated financial system those savings are kept in is actually well placed to deal with repayment delays and defaults.




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Most obviously, China’s banks are highly liquid. Their deposit-taking more than matches their loan-making, and they keep a fifth of their deposits in reserve at the central bank. That gives the banks some scope to roll over troublesome loans that may be repaid at a later date, or written off at a more convenient time. But there is also the backstop of the central government, which has formal debts amounting to only about 25% of GDP. Local-government debts might double that proportion, but China plainly has enough fiscal space to recapitalise any bank threatened with insolvency.




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That space also gives the government room to stimulate growth again, should exports to Europe fall off a cliff. China’s government spent a lot on infrastructure when the credit crunch struck its customers in the West. But there is no shortage of other things it could finance. It could redouble its efforts to expand rural health care, for example. China still has only one family doctor for every 22,000 people. If ordinary Chinese knew that their health would be looked after in their old age, they would save less and spend more.
Household consumption accounts for little more than a third of the economy.



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Time is on my side



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That underlines the longer-term problem China faces. The same quirks and unfairnesses that would help it withstand a shock in the next few years will, over time, work against the country. China’s phenomenal saving rate will start falling, as the population ages and workers become more expensive.



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Capital is also already becoming less captive. Fed up with the miserable returns on their deposits, savers are demanding alternatives. Some are also finding ways to take their money out of the country, contributing to unusual downward pressure on the currency. China’s bank deposits grew at their slowest rate on record in the year to April.



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So China will have to learn how to use its capital more wisely. That will require it to lift barriers to private investment in lucrative markets still dominated by wasteful SOEs. It will also require a less cosseted banking system and a better social-security net, never mind the political and social reforms that will be needed in the coming decade.





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China’s reformers have a big job ahead, but they also have some time. Pessimists compare it to Japan, which like China was a creditor nation when its bubble burst in 1991. But Japan did not blow up until its income per head was 120% of America’s (at market exchange rates). If China’s income per head were to reach that level, its economy would be five times as big as America’s. That is a long way off.


ECONOMY
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Updated May 24, 2012, 7:26 p.m. ET
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New Signs of Global Slowdown
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Weak Reports in U.S., Europe and China Suggest Economies Are Slipping in Sync
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By JON HILSENRATH and JOSHUA MITCHELL


A slew of data this week suggests that the global economy is slowing down. Dow Jones's Paul Hannon examines data from the U.S., Europe and China to assess how bad things are on the economic front. Photo: Getty







New signs of a global slowdown are darkening the economic outlook.


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On Thursday, the U.S. reported that businesses were slowing their orders of computers, aircraft, machinery and other long-lasting goods. Measures of business sentiment in Europe slipped, and reports from purchasing managers at manufacturers around the globe turned down. Among them, China, the world's second-largest economy, registered its seventh straight drop in an important manufacturing index.

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With the latest reports, a new economic threat is emerging: That activity is slowing in sync around the globe and not just in a few markets with their own isolated problems. Europe, struggling with the risk of a Greek pullout from the euro area and broader fiscal problems, is the epicenter of global economic concerns right now. But reports of economic trouble are turning up in China, India, South Africa, Brazil and elsewhere.



.When the global economy is performing well, synchronized growth reinforces itself and spreads prosperity wide and far. But slowdowns can become interconnected and self-reinforcing, and the global economy has been plagued by them since the financial crisis of 2008..
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 .Andrea Comas/Reuters
Protesters opposed to Spanish labor reforms scuffle with police on Thursday in Madrid.


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The Organization for Economic Cooperation and Development earlier this week cut its 2012 forecast for growth in developed economies. The International Monetary Fund sees the global economy growing more slowly than 2011's 3.9% rate.



Economic weakening, in turn, means investors are taking it on the chin. The MSCI World Index for stocks, which tracks markets around the globe, is down more than 9% since mid-March. Crude oil prices, another proxy for global demand, are down 15% so far this month.


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Taken together, this could lead to new pressure on policy makers to respond with growth-boosting measures. The Federal Reserve so far has been noncommittal about whether it would launch any new measures to stimulate the U.S. economy. European officials are under intense pressure to back away from austerity measures, and the Chinese are looking for new ways to boost growth.



Many firms are pointing to troubles away from their home bases. Gary Hendrickson, CEO of Valspar Corp., VAL +0.08%a Minneapolis-based global paint supplier, told investment analysts Wednesday that almost all of its businesses in China had weakened. Valspar reported a 36% jump in profit earlier this month, but disappointed analysts with projections for the rest of the year.



Informatica Corp., INFA -0.37%of Redwood City, Calif., which makes software that helps companies integrate data, is seeing weaker sales in Europe, particularly in the public sector, Chief Executive Sohaib Abbasi said at an industry conference this week.



In last year's first quarter, the company secured a pair of $1 million deals with European governments. In this year's first quarter, it secured none, Mr. Abbasi said. Sales to European governments accounted for 1% of revenue in the first quarter, below the typical 3% to 5%, he said.




"The austerity measures have had an impact," Mr. Abbasi said. But the company is still seeing double-digit growth in other regions, including Latin America and Asia Pacific, he said.



"The worry is whether Europe will be worse than we anticipated before," Hewlett-Packard HPQ -0.55%CEO Meg Whitman said Wednesday while announcing plans to lay off 27,000 workers. As of now, she said she didn't see Europe's woes having a major impact on the company's U.S. business this year. "But I don't think anyone really knows," she added.







David Resler, an economist with Nomura Securities, said, "The dangers of a slowdown in Europe taking a bigger toll on the global economy have absolutely risen." He added that "we don't think there will be a global recession, but it could keep the world economy from growing vigorously."



Other regions are showing their own cracks. Brazil's central bank estimates its economy contracted in each of the first three months of this year, as poor industrial-output figures offset gains in retail sales.




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Many Brazilian industries have struggled with rising costs of labor, rent and materials, which have turned it into one of the world's most expensive places to do business. What's more, Brazil may be exposed to a slowdown in China, Brazil's biggest trade partner and a primary consumer of its iron ore, soy and other commodities.
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In South Africa, mining is hurting as demand for some commodities cools off. Lonmin LMI.LN -2.36%PLC, the world's third-largest platinum producer, warned this month it might reduce spending at mines in South Africa because global demand for the metal is weak. Manufacturing production unexpectedly fell by 2.7% annually in March, the government's statistics agency said this month.



Infosys Ltd., INFY -0.07%the Indian outsourcing giant, posted a 1.9% decline in U.S. dollar revenues in the three months ended in March, its first quarterly drop since 2009, and the company projects single-digit growth in the current fiscal year, which is slow by its standards.



S.D. Shibulal, Infosys's CEO, said last month many U.S. financial-services clients now make spending decisions monthly, rather than annually. That gives them more chances to hit the brakes. Weak U.S. technology investment is a nagging concern.



In the U.S., new orders for computers and electronics fell by 0.6% in April from a month earlier, after falling 0.8% in March, Commerce Department data released Thursday showed. In all, new orders were up 0.2% in April after a 3.7% drop in March. But nondefense capital-goods orders excluding aircraft, a closely watched proxy for business spending plans, fell 1.9% in April after dropping 2.2% in March.





Still, the U.S., after being the center of global trouble four years ago, might be a relative bright spot now. Recent indicators suggest that a long-dormant housing market is starting to recover, and job growth is stronger than it was last year. A steady U.S. economy could bolster the rest of the world.



J.P. Morgan Chase economist Bruce Kasman pointed out that consumer spending globally is stable. If it remains so in coming months, manufacturers could ramp up production this summer as inventories thin out, he said.



"I think you set yourself up for decent opportunity for a lift," assuming that the European crisis doesn't severely depress global demand, Mr. Kasman said.



One important risk to that forecast is China. On Thursday, HSBC Holdings PLC said its closely watched purchasing-managers index fell to a preliminary reading of 48.7 in May from 49.3 in April, indicating that manufacturing activity declined for the seventh-straight month in China. A reading below 50 indicates contraction, above 50, expansion. The May report follows a series of weak readings for April on everything from foreign trade to bank lending. Beijing is turning to a patchwork of initiatives across areas it hopes will spur growth and complement its long-term drive toward an economy powered by more consumption, innovation and private-sector activity.



Some analysts see a more concerted government effort by Chinese authorities if growth doesn't pick up.



"If loan growth and investment fail to pick up soon, the state sector will come under heavy pressure to start spending," said Mark Williams, an economist at research firm Capital Economics, in a note. "Prospects that the economy will soon be put on a more sustainable, more consumer-led footing still look remote."


—John Lyons, Aaron Back, Patrick McGroarty, Ben Worthen and Tom Wright contributed to this article.


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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved


My Speech to the Finance Graduates
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Robert J. Shiller

22 May 2012
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NEW HAVEN – At this time of year, at graduation ceremonies in America and elsewhere, those about to leave university often hear some final words of advice before receiving their diplomas. To those interested in pursuing careers in finance – or related careers in insurance, accounting, auditing, law, or corporate management – I submit the following address:


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Best of luck to you as you leave the academy for your chosen professions in finance. Over the course of your careers, Wall Street and its kindred institutions will need you. Your training in financial theory, economics, mathematics, and statistics will serve you well.
But your lessons in history, philosophy, and literature will be just as important, because it is vital not only that you have the right tools, but also that you never lose sight of the purposes and overriding social goals of finance.



Unless you have been studying at the bottom of the ocean, you know that the financial sector has come under severe criticism much of it justified – for thrusting the world economy into its worst crisis since the Great Depression. And you need only check in with some of your classmates who have populated the Occupy movements around the world to sense the widespread resentment of financiers and the top 1% of income earners to whom they largely cater (and often belong).



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While some of this criticism may be over-stated or misplaced, it nonetheless underscores the need to reform financial institutions and practices. Finance has long been central to thriving market democracies, which is why its current problems need to be addressed. With your improved sense of our interconnectedness and diverse needs, you can do that. Indeed, it is the real professional challenge ahead of you, and you should embrace it as an opportunity.



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Young finance professionals need to familiarize themselves with the history of banking, and recognize that it is at its best when it serves ever-broadening spheres of society. Here, the savings-bank movement in the United Kingdom and Europe in the nineteenth century, and the microfinance movement pioneered by the Grameen Bank in Bangladesh in the twentieth century, comes to mind. Today, the best way forward is to update financial and communications technology to offer a full array of enlightened banking services to the lower middle class and the poor.


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Graduates going into mortgage banking are faced with a different, but equally vital, challenge: to design new, more flexible loans that will better help homeowners to weather the kind of economic turbulence that has buried millions of people today in debt.


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Young investment bankers, for their part, have a great opportunity to devise more participatory forms of venture capital embodied in the new crowd-funding Web sites – to spur the growth of innovative new small businesses. Meanwhile, opportunities will abound for rookie insurance professionals to devise new ways to hedge risks that real people worry about, and that really matter – those involving their jobs, livelihoods, and home values.



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Beyond investment banks and brokerage houses, modern finance has a public and governmental dimension, which clearly needs reinventing in the wake of the recent financial crisis. Setting the rules of the game for a robust, socially useful financial sector has never been more important. Recent graduates are needed in legislative and administrative agencies to analyze the legal infrastructure of finance, and regulate it so that it produces the greatest results for society.


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A new generation of political leaders needs to understand the importance of financial literacy and find ways to supply citizens with the legal and financial advice that they need. Meanwhile, economic policymakers face the great challenge of designing new financial institutions, such as pension systems and public entitlements based on the solid grounding of intergenerational risk-sharing.


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Those of you deciding to pursue careers as economists and finance scholars need to develop a better understanding of asset bubbles – and better ways to communicate this understanding to the finance profession and to the public. As much as Wall Street had a hand in the current crisis, it began as a broadly held belief that housing prices could not fall – a belief that fueled a full-blown social contagion. Learning how to spot such bubbles and deal with them before they infect entire economies will be a major challenge for the next generation of finance scholars.


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Equipped with sophisticated financial ideas ranging from the capital asset pricing model to intricate options-pricing formulas, you are certainly and justifiably interested in building materially rewarding careers. There is no shame in this, and your financial success will reflect to a large degree your effectiveness in producing strong results for the firms that employ you. But, however imperceptibly, the rewards for success on Wall Street, and in finance more generally, are changing, just as the definition of finance must change if is to reclaim its stature in society and the trust of citizens and leaders.


.Finance, at its best, does not merely manage risk, but also acts as the steward of society’s assets and an advocate of its deepest goals. Beyond compensation, the next generation of finance professionals will be paid its truest rewards in the satisfaction that comes with the gains made in democratizing financeextending its benefits into corners of society where they are most needed. This is a new challenge for a new generation, and will require all of the imagination and skill that you can bring to bear.


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Good luck in reinventing finance. The world needs you to succeed.


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Robert J. Shiller is Professor of Economics at Yale University and the co-creator of the Case-Shiller Index of US house prices. His book Irrational Exuberance presciently warned of the dot-com bubble, and a second edition, released in 2005, predicted the coming collapse of the real-estate bubble. His most recent book, co-written with George Akerlof, is Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism