World leaders play war games as the next financial crisis looms

Global community can see dark forces gathering but lacks the weapons or the will to tackle them effectively, writes Larry Elliott

Larry Elliott, economics editor

Sunday 12 October 2014 13.24 BST.

Winston Churchill, Field-Marshal Montgomery and Field-Marshal Sir Alan Brooke, 1945
Winston Churchill, Field-Marshal Montgomery and Field-Marshal Sir Alan Brooke, 1945. George Osborne is also going on manoeuvres. Photograph: Fred Ramage/Getty Images


Press the uniform. Check the battle plans. Call up the reservists. Arm the bombers and refuel the tanks. Field Marshal George Osborne is going on manoeuvres.

On Monday in Washington, the chancellor of the exchequer will see if Britain is ready for war.

A financial war that is. Along with his allies from the United States, he will play out a war game designed to show whether lessons have been learned from the last show, the slump of 2008.

Like all commanding officers, Osborne thinks he is ready. He will have general Mark Carney at his side. He has studied the terrain. He has a plan that he insists will work.

Let’s hope so. Because the evidence from last week’s meeting of the International Monetary Fund in Washington was that it won’t be long before the real shooting starts. The Fund’s annual meeting was like a gathering of international diplomats at the League of Nations in the 1930s. Those attending were desperate to avoid another war but were unsure how to do so.

They can see dark forces gathering but lack the weapons or the will to tackle them effectively.

There is an uneasy, brooding peace as the world waits to see whether lessons really have been learnt or whether the central bankers, the finance ministers and the international bureaucrats are fighting the last war.

Here’s the situation. The years leading up to the start of the financial crisis in August 2007 were like the Edwardian summer in advance of the first world war. All seemed serene, but only because of an unsustainable build-up in debt. There was a structural shift in power and income share from labour to capital. Rising asset prices compensated for real income growth.

Then came the crisis, which was long and costly. Once it was over, there was a strong urge to return to the world as it was. Countries wanted to return to balanced budgets and normal levels of interest rates, just as they had once hankered after going back on the Gold Standard.

But that proved impossible. Six years after the global banking system had its near-death experience, interest rates are still at emergency levels. Even attaining the mediocre levels of activity expected by the IMF in the developed countries requires central banks to continue providing large amounts of stimulus. The hope has been that copious amounts of dirt-cheap money will find its way into productive uses, with private investment leading to stronger and better balanced growth.

It hasn’t happened like that. Instead, as the IMF rightly pointed out, the money has not gone into economic risk-taking but into financial risk-taking. Animal spirits of entrepreneurs have remained weak but asset prices have been strong. Tighter controls on banks have been accompanied by the emergence of a powerful and largely unchecked shadow banking system.

Investors have been piling into all sorts of dodgy-looking schemes, just as they did pre-2007.

Recovery, such as it is, is once again reliant on rising debt levels. Central bankers know this but also know that jacking up interest rates to would push their economies back into recession. They cross their fingers and hope for the best.

Meanwhile, the legacy of the slump has been high levels of unemployment and growing inequality. In those economies where jobs have been created, such as the UK, they have tended to be of the low pay, low skill and low productivity variety. Profits have recovered; real incomes have not.

Christine Lagarde, the IMF’s managing director, says inequality must be tackled. The Fund has produced papers showing that a more even distribution of income and wealth would be good for growth. The words “shared prosperity” were on everybody’s lips in Washington last week.

But as some sceptics pointed out, so far the fight against inequality is currently a phoney war.

Lagarde talks a good game, but the advice her organisation dispenses to individual countries has not really changed. There were four things that ensured shared prosperity in the 1950s and 1960s: strong trade unions; redistribution through the tax system; higher public spending; and curbs on the financial system. Apart from suggesting that some countries, such as Germany, might care to spend a bit more on infrastructure, the Fund is not really in favour of any of them. The message, therefore, is clear enough. Lagarde et al are worried about inequality. But they are not yet worried enough to do much about it.

This is where the comparison with the 1920s and 1930s gets scary. The problems created by the first world war were never properly dealt with, and it was only after the Great Depression and a second conflict that policies changed and global institutions were made fit for purpose. There is a real danger of history repeating itself.

The Fund, for example, knows that something is going badly wrong in Europe but is powerless to do anything about it. In the rest of the world, IMF policy is normally governed by what the US Treasury wants. In the euro zone, it is governed by what Germany wants. And what Germany wants is to turn the euro into the modern equivalent of the Gold Standard, with every country running balanced budgets. What Germany is getting is a eurozone in semi-permanent recession. There are alternatives to the status quo: full political union; break-up; a German Marshall Plan for Europe; dumps of helicopter money. Eventually one of them will be tried.

Similarly, the IMF is alert to the threat of another financial crisis. It knows that much of the cash created by central banks has found its way, via the shadow banking system, into emerging markets and developing countries. It knows that investors are complacent about the risks. It knows that in a rush for the exit, many of these investors would be badly burned.

There is, though, no mechanism for regulating these financial flows, just as there is no mechanism for dealing with countries when they go bust. The vulture fund case against Argentina should be the trigger for a sovereign debt bankruptcy system. Instead, the global community is sleepwalking its way towards a developing country debt crisis.

But for the time being, it is easier to avoid doing anything. The rich can enjoy their Great Gatsby lifestyles. Multinational corporations can strip poor countries of their commodities and pay their taxes elsewhere, if at all. Living standards can continue to be squeezed. Debt levels can continue to rise.

Only a real scare, as with Ebola, will lead to meaningful action. Until then, though, the Fund can sit behind its Maginot Line and Field Marshal Osborne can play his war games. But be in no doubt: our chancellor is less Monty in the desert than Neville Chamberlain declaring peace in our time.


The great Lira revolt has begun in Italy

The biggest single party in the Italian parliament by votes has thrown down the gauntlet, calling for a euro referendum to end depression and save democracy, writes Ambrose Evans-Pritchard

By Ambrose Evans-Pritchard

6:15PM BST 13 Oct 2014
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Leader of Italy's Five Star movement, Beppe Grillo


The die is cast in Italy. Beppe Grillo’s Five Star movement has launched a petition to drive for Italian withdrawal from Europe’s monetary union and for the restoration of economic sovereignty.
 
“We must leave the euro as soon as possible,” said Mr Grillo, speaking at a rally over the weekend. 
 
“Tonight we are launching a consultative referendum. We will collect half a million signatures in six months – a million signatures – and we will take our case to parliament, and this time thanks to our 150 legislators, they will have to talk to us.”
 
Ever since the pugnacious comedian burst on the political scene, the eurozone elites have comforted themselves that the party is not really Eurosceptic at heart, and certainly does not wish bring back the lira. This illusion has been shattered.
 
A referendum itself would not be binding, but a “law of popular initiative” certainly would be. For the first time, a process is underway in Italy that will set off a national debate on monetary union and may force a vote on EMU membership that cannot easily be controlled.

Gianroberto Casaleggio, the party’s co-founder and economic guru, told me today that the Five Star Movement - or Cinque Stelle - had set out its demands in May, calling for the creation of Eurobonds to back up EMU, as well as the abolition of the EU Fiscal Compact. “Five months have gone by and we have had no reply. They have totally ignored us,” he said.
 
The Fiscal Compact is economic insanity. It would force Italy to run massive fiscal surpluses for decades. These would cause an even deeper depression, pushing the debt ratio even higher, and would therefore be scientifically self-defeating. Historians will issue a damning verdict on the scoundrels who foisted this atrocity on Europe.
 
My own view is that Italy could not restore viability within EMU even if Germany agreed to the two conditions (an impossible idea). It is already too late for that. Italy has lost 40pc in unit labour cost competitiveness against Germany since the Deutsche Mark and the lira were fixed in perpetuity in the mid 1990s.
 
Any attempt to carry out an Irish-style “internal devaluation” in a closed economy in conditions that are already deflationary would be suicidal, triggering a collapse of the Italian banking system and an explosion of public and private debt ratios. I suspect that Mr Casaleggio holds the same view. “A quarter of Italian industry has disappeared. Our currency is overvalued and there is nothing we can do about it within the euro,” he said.
 
The Five Star critique of EMU is not purely economic, a point of crucial significance. It is defending Italian sovereignty, self-government, and democracy against the encroachments of an EU machinery that has usurped parliamentary functions.
 
“I don’t give away my sovereignty to anybody,” said Mr Casaleggio.
 
“My grandfather fought with the partisans for three years. If you want my sovereignty, you have to come and take it, not by waving some letter from the ECB. You have to come well-armed, as they tried once before,” he said.
 
The ECB letter – La Lettera as it is known simply in Italy – was the secret diktat sent to Italy’s leader Silvio Berlusconi in August 2011. It demanded drastic “reforms” of all kinds. A similar letter was sent to Spain’s leader. The quid pro quo was bond purchases.
 
The implicit threat was that the ECB would refuse to carry out its responsibility as lender-of-last resort unless Mr Berlusconi capitulated. He did not, or was deemed not to have done so. Bond purchases were halted. Italy’s 10-year yields spiralled above 7pc. Mr Berlusconi was toppled.
 
I have always thought these two letters would come back to haunt the ECB, and monetary union itself, and so it is now unfolding.
 
“[Mario] Draghi [the president of the ECB] has told us that governments that don’t reform will be thrown out. He is not a member of the government and I don’t know with what authority he demands these reforms. He has no right to order us around, either directly or indirectly,” said Mr Casaleggio.

Cinque Stelle won 26pc of the vote in Italy’s general elections last year, more than any other single party. (It did not win the biggest bloc of seats because of the way the parliamentary system is designed). It has 108 deputies in the lower house, and 54 senators.
 
It is true that premier Matteo Renzi has stolen Beppe Grillo’s thunder this year but Cinque Stelle has not faded away. It came second in the European elections in May, winning 21.5pc of the vote. Its 17 MEPs sit with UKIP in Strasbourg.
 
Mr Renzi’s honeymoon is already over, and he has in any case made a strategic misjudgement. The young Wunderkind snatched power in an internal party coup in February – with tactical brilliance, to be sure – on the assumption that Italy had touched bottom after six years of depression, a 9.1pc fall in output, a 24pc crash in industrial production, and youth unemployment of 43pc.
 
He believed the mantra, so widely put about, that Europe was on the cusp of a fresh cycle of self-sustaining recovery, lifted off the reefs by world growth, and that all he had to do was to float on the rising tide. Instead, it has crashed back into slump.
 
Mr Renzi’s error is understandable. Wishful thinking has been pervasive, even though such recovery claims skate over Irving Fisher’s theories of debt deflation, or Knut Wicksell’s theories of self-feeding spirals caused by credit contraction and misaligned interest rates, or indeed Michael Woodford’s more recent theories of the real exchange rate.
 
Italy is already in a triple-dip recession, its output back to levels first reached fourteen years ago. The OECD says the slump will drag on through most of next year. Growth will be just 0.1pc in 2015.
 
Note that the Monti government said three years ago that Italy’s debt ratio would end 2014 at 115pc.

In fact it reached 135.6pc of GDP in the first quarter this year, soaring at a rate of 5pc of GDP each year, despite a series of austerity packages, and a primary budget surplus of 2.5pc.
 
Antonio Guglielmi from Mediobanca warned last month, that this is “catastrophic for the finances of the country”. The debt will automatically rocket towards 145pc next year (under the old measure, cut to 140pc under new accounting rules). “It is going to take a nuclear bomb to turn this around. If Draghi ends up doing almost nothing, Italy is dead,” he said.
 
This is not a moral failing by Italy over recent years. It is a mechanical “denominator effect”, the result of a rising debt burden on a shrinking base of nominal GDP.
 
The point is very simple. The average interest rate on Italy’s public debt is still around 4pc, so interest payments are near 5.5pc of GDP. Unless nominal GDP grows at the same speed, the debt ratio must keep going up. Structural reform is no doubt desirable as an end in itself, but it has nothing to do with the matter at hand.
 
Italy’s current crisis is ENTIRELY due to monetary policy failure and the refusal of the ECB to meet its inflation target, or to comply with its own Lisbon Treaty obligations to support growth. (And yes, it does have a dual mandate under EU Treaty law.) The more that Italy carries out drastic reforms in these circumstances, the worse it will get. The short-term effects of reform are famously contractionary.
 
We have reached a remarkable state of affairs in all three of EMU’s leading economies: France’s Front National swept to victory in the European elections in May with calls for an immediate return of the French franc; Germany’s anti-euro party AfD has suddenly broken into three state parliaments with calls for a return of the Deutsche Mark; and now Cinque Stelle wants a return of the lira in a country that has been reliably and passionately pro-European for sixty years.
 
Takes some doing.


Are Services the New Manufactures?

Dani Rodrik

OCT 13, 2014

Are services the new manufactures
 
PRINCETON – The global discussion about growth in the developing world has taken a sharp turn recently. The hype and excitement of recent years over the prospect of rapid catch-up with the advanced economies have evaporated. Few serious analysts still believe that the spectacular economic convergence experienced by Asian countries, and less spectacularly by most Latin American and African countries, will be sustained in the decades ahead. The low interest rates, high commodity prices, rapid globalization, and post-Cold War stability that underpinned this extraordinary period are unlikely to persist.
 
A second realization has sunk in: Developing countries need a new growth model. The problem is not just that they need to wean themselves from their reliance on fickle capital inflows and commodity booms, which have often left them vulnerable to shocks and prone to crises. More important, export-oriented industrialization, history’s most certain path to riches, may have run its course.
 
Ever since the Industrial Revolution, manufacturing has been the key to rapid economic growth. The countries that caught up with and eventually surpassed Britain, such as Germany, the United States, and Japan, all did so by building up their manufacturing industries.
 
Following the Second World War, there were two waves of rapid economic convergence: one in the European periphery during the 1950s and 1960s, and another in East Asia since the 1960s.
 
Both were based on industrial manufacturing. China, which has emerged as the archetype of this growth strategy since the 1970s, traveled a well-worn path.
 
But manufacturing today is not what it used to be. It has become much more capital- and skill-intensive, with greatly diminished potential to absorb large amounts of labor from the countryside.
 
 


Credit Markets

U.S. 10-Year Treasury Yield Dips Below 2%

Latest Round of U.S. Data Heightens Worries Over the Global Economic Outlook

By Min Zeng

Updated Oct. 15, 2014 2:06 p.m. ET


Yields on U.S. government bonds plunged, with the rate on the 10-year benchmark note dipping below 2% for the first time since June 2013, as anxiety over global growth intensified.
 
Investors have been snapping up ultrasafe governments bonds in recent days. The rush turned into a stampede on Wednesday morning, following two disappointing readings on the U.S. economy.
 
Trading was frenetic early in the session, with the yield tumbling 0.14 percentage point within 10 minutes of the start of volatile trading in U.S. stocks. That slide is on par with intraday moves seen during the eurozone’s debt crisis in 2011.
 
The 10-year Treasury yield fell as low as 1.873%, its lowest level in intraday trading since May 2013, according to Tradeweb. Recently, the yield was at 2.039%. When bond yields fall, prices rise.
 
One factor fueling the rush to buy bonds on Wednesday, traders said: Hedge funds and other short-term bond investors who scrambled to cover soured wagers that bond yields would rise and prices fall.
 
“It was confusion, chaos and fear,’’ said Russ Certo, managing director of rates trading at Brean Capital LLC in New York. “It is emotional capitulation going through the bond market as bears unwound their short bets. It is frenetic.”
 
Shopping at a Wal-Mart store in Arkansas. A decline in U.S. retail sales last month added to concerns about U.S. growth. Associated Press
            

Some bond traders expressed shock over the tumble in yields. The record low for the 10-year Treasury yield is 1.38%, reached in July 2012 at the height of jitters over Europe’s sovereign-debt burden.

“I am speechless and stunned,’’ said David Coard, head of fixed-income trading in New York at Williams Capital Group. “The U.S. has been in the best employment situation for years. Right now there is just a lot of emotion going through the bond market.”

U.S. retail sales in September declined by a bigger-than-expected 0.3%, and a reading of the business outlook for the New York region slowed sharply. Meanwhile, the producer-price index, a gauge of wholesale inflation, fell by 0.1% in September amid a slide in energy prices. The data amplified worries about the U.S.’s ability to withstand economic slowdowns elsewhere and came as deflation fears have taken hold in Europe, spurring a global flight to safety that has upended markets from stocks to bonds to oil.
 
“It just seems everywhere one looks, none of the news is good news and as such there is little else to buy other than Treasurys,” said Anthony Cronin, a Treasury bond trader at Société Générale SA.
 
Trading volume climbed as investors piled in. About $445 billion worth of Treasury bonds had changed hands as of 10 a.m., the most for that time period since May 2 and compared with an average of $144 billion in the past month, according to Adrian Miller, director of fixed-income strategies at GMP Securities LLC.
 
Other financial assets that are considered safer also drew buyers Wednesday. The 10-year German government bond’s yield fell to a record low of 0.754%, according to Tradeweb. The 10-year U.K. government bond’s yield dropped to 1.975%. The Japanese yen was recently trading up by more than 1% versus the dollar, according to CQG.
 
Wednesday’s gains extended this year’s rally in relatively safe government bonds, a trend that had caught many money managers and strategists by surprise, coming even as the U.S. Federal Reserve has cut back its bond purchases.
 
But signs of weak global economic growth have sent gauges of inflation expectations into free fall, sending ripples through financial markets. The Dow Jones Industrial Average recently was down more than 400 points, or 2.5%, heading toward its fifth-straight day of losses.
 
Falling bond yields could be a boon for U.S. consumers and businesses. The 10-year note’s yield is a benchmark to set long-term borrowing costs in the U.S. economy. Companies have also been locking in low interest rates as they sell long-term bonds this year. The Mortgage Bankers Association reported Wednesday that the rate on the average 30-year fixed-rate loan fell to 4.2% last week, from 4.3% the week before. Rates stood as high as 4.72% at the beginning of the year.
 
Bond traders and investors have dialed back expectations for the timing of the first interest rate increases from the U.S. and U.K. central banks amid signs of weak demand in Europe and Asia, and persistent geopolitical risks. Many investors now believe policy makers may wait until the second half of 2015—if not longer—to raise short-term interest rates.
 
Fed officials flagged weaker growth in Europe at last month’s monetary-policy meeting as one reason to be patient in raising interest rates. U.S. central bankers have also become more concerned about the impact of a strengthening U.S. dollar on the domestic economy, according to minutes of the Fed’s September policy meeting released last week. The stronger U.S. dollar, by reducing the cost of imported goods and services, could help hold U.S. inflation below the Fed’s 2% objective. Fed staff reduced their projection for medium-term growth in part because of these concerns.
 
Few investors expect the U.S. to slip into deflation, a cycle in which falling consumer prices lead to spending reductions and declining economic activity. Even in Europe, officials say the risks of deflation remain limited.
 
But an inflation gauge closely watched by European Central Bank President Mario Draghi fell Wednesday to the lowest in at least a decade. The five-year/five-year inflation swap rate, which measures investors’ expectations for inflation in the eurozone over the course of five years starting five years from now, fell to 1.744% Wednesday, according David Keeble, global head of interest-rates strategy at Crédit Agricole in New York.
 
In the U.S., the yield spread between a 10-year Treasury inflation-protected security and a 10-year Treasury note, fell nearly 0.07 percentage point to 1.840 percentage points. That suggests investors expect the U.S. inflation rate will average 1.840% within a decade. That so-called break-even rate was 2.242 percentage points at the end of 2013.
 
Lower inflation expectations encourage investors to buy bonds because the risk diminishes of higher consumer prices eating away bonds’ value. In a deflationary environment, bonds actually get a boost in purchasing power.




October 13, 2014 2:44 pm

 
America, Britain and the perils of empire
 
Middle East turmoil of 1919 offers important lessons for today




General Sir Philip Chetwode, deputy chief of Britain’s Imperial General Staff, warned in 1919:

 “The habit of interfering with other people’s business and making what is euphoniously called ‘peace’ is like buggery; once you take to it, you cannot stop.”

It is difficult to imagine any member of the Obama administration making such an eyebrow-raising comparison. But, as the US struggles to cope with turmoil across the Middle East, Sir Philip’s complaint – quoted in David Reynolds’s recent book, The Long Shadow – has a contemporary ring to it. Even more so the lament of his boss, Sir Henry Wilson, the chief of Britain’s Imperial General Staff, who complained in 1919 that -”we have between 20 and 30 wars raging in the world” and blamed the chaotic international situation on political leaders who were “totally unfit and unable to govern”.

Britain was directly or indirectly involved in the fighting in many of these wars during the years 1919-1920. Their locations sound familiar: Afghanistan, Waziristan, Iraq, Ukraine, the Baltic states. Only Britain’s involvement in a war in Ireland would ring no bells in the modern White House. The British debates, and recriminations of the time are also strongly reminiscent of the arguments that are taking place in modern America. And how events panned out holds some important lessons for today’s policy makers.

The British military effort in Iraq in 1920, like the allied effort today, was conducted largely through aerial bombing. Then, as now, there was strong scepticism about the long-term chances of achieving political stability in such an unpromising environment. AJ Balfour, the British foreign secretary complained – “We are not going to spend all our money and men in civilising a few people who do not want to be civilised.” In an echo of America’s current Middle East confusion, even British policy makers knew that they were pursuing contradictory goals.

As Professor Reynolds points out – “The British had got themselves into a monumental mess in the Middle East, signing agreements that, as Balfour later admitted, were ‘not consistent with each other’.”


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Technology

The Big Mystery: What’s Big Data Really Worth?

A Lack of Standards for Valuing Information Confounds Accountants, Economists

By Vipal Monga

Oct. 12, 2014 7:39 p.m. ET

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 Supermarket chain Kroger collects a wealth of data from its 55 million customer loyalty-card members, but the data isn’t treated as an asset. Robert Bratney for The Wall Street Journal
 
 
What groceries you buy, what Facebook posts you “like” and how you use GPS in your car: Companies are building their entire businesses around the collection and sale of such data.
 
The problem is that no one really knows what all that information is worth. Data isn’t a physical asset like a factory or cash, and there aren’t any official guidelines for assessing its value.
 
“It’s flummoxing that companies have better accounting for their office furniture than their information assets,” said Douglas Laney, an analyst at technology research and consulting firm Gartner Inc. “You can’t manage what you don’t measure.”
 
As more companies traffic in information and use big-data analytic tools to find ways to generate revenue, the lack of standards for valuing data leaves a widening gap in our understanding of the modern business world.
 
Corporate holdings of data and other “intangible assets,” such as patents, trademarks and copyrights, could be worth more than $8 trillion, according to Leonard Nakamura, an economist at the Federal Reserve Bank of Philadelphia. That’s roughly equivalent to the gross domestic product of Germany, France and Italy combined.
 
These intangibles are becoming an evermore important part of the global economy. The value of patents, for example, has become a major driver of both mergers and lawsuits for technology giants like Google Inc., Apple Inc. and Samsung Electronics Co. But those assets don’t appear on company financial statements.
 
“We want some kind of accounting information about it, so you have a better idea of how companies are investing for growth,” said Mr. Nakamura.
 
The issue isn’t confined to the tech industry. Supermarket operator Kroger Co. records what customers buy at its more than 2,600 stores and also tracks the purchasing history of its roughly 55 million loyalty-card members. It sifts this data for trends and then, through a joint venture, sells the information to the vendors who stock its shelves with goods ranging from cereals to sodas.
 
Consumer-products makers like Procter & Gamble Co.and Nestlé SA are willing to pay for those insights because it allows them to tailor their products and marketing to consumer preferences.
 
Mr. Laney and others estimate that Kroger rakes in $100 million a year from data sales. But Kroger executives are mum on the subject.
 
Kroger does say that it follows generally accepted accounting principles, which prohibit companies from treating data as an asset or counting money spent collecting and analyzing the data as investments instead of costs.
 
The Financial Accounting Standards Board, the nation’s accounting authority, has struggled to update its rules for an economy increasingly driven by information and intellectual property. FASB has debated the question of intangible assets twice between 2002 and 2007. Both times, complications convinced the agency to drop it from the agenda. Last month, however, members of the advisory council again advised the board to research intangibles, said agency spokeswoman Christine Klimek.
                                         
Among the issues: how to account for time employees spent gathering data—as an expense or a capital investment?
 
Companies also would have to estimate the shelf-life of their data, figure out its future worth and track and report any changes in its value. Crunching those numbers would be relatively easy for a physical asset like a factory. But in the squishy world of intangibles, there’s little precedent for such calculations.
 
“When those kinds of questions arise, they overwhelm the matter,” said Dennis Beresford, who was FASB’s chairman from 1987 to 1997.
 
The lack of consensus on how to measure data’s value creates an especially big blind spot for investors in tech giants like Facebook Inc., eBay Inc. and Google, which rely on the data they collect for the bulk of their revenue.
 
“A lot of what is going on at the companies is not being reflected in public disclosures or the accounting,” said Glen Kernick, a managing director at investment-banking and valuation advisory firm Duff & Phelps Corp.
 
Facebook, eBay and Google have combined assets minus combined debt of $125 billion. But the combined value of shares is $660 billion. The difference reflects the stock market’s understanding that the companies’ prize assets, such as search algorithms, patents and enormous troves of information on their users and customers, don’t show up on their balance sheets. That leads many investors to value them by other, more volatile benchmarks, such as cash flow or the economic outlook.
 
Many experts argue that investors don’t need to know the specific value of intangible assets like data. They say a company’s stock price reflects the market’s appraisal of those assets.
 
“Data is worthless if you don’t know how to use it to make money,” said Laura Martin, an analyst with Needham & Co. Information on individual users loses value over time as they move or their tastes change, she added. That makes data a perishable commodity and more difficult to value at any given moment.
 
But relying on the collective wisdom of the market can be dangerous. Many investors lost their shirts in the dot-com bust of 2000, which followed a buying frenzy fueled by the widespread belief that traditional metrics for value and risk didn’t matter in the “new economy.”
 
One of the rare times that companies put a price tag on data is during corporate takeovers. In fact, the value of the data to be acquired in a deal is becoming an important consideration in mergers, said Bruce Den Uyl, managing director at consulting firm AlixPartners LLP.
 
Nielsen Holdings NV, which tracks what people watch on television and buy in stores, acquired radio-audience tracker Arbitron Inc. for $1.3 billion in September 2013. As part of that deal, Nielsen broke out the intangible assets it acquired on its balance sheet, including “customer-related intangibles” worth $271 million.
 
That item included the value of long-term customer relationships as well as customer lists, but Nielsen didn’t specify how much it paid for either.
 
Nielsen doesn’t give a value for the data it has created on its own. But it assigned a value of $1.98 billion of customer-related intangibles and $4.82 billion of other intangibles it had acquired as of the end of the first quarter.
 
Nielsen declined to comment.
 
Mr. Den Uyl said that he values data based on how companies will use it to make money, and its expected life. He likened the process to solving a puzzle, in which he first values all the other acquired assets and then assigns some of what’s left to data and goodwill.
 
A spate of hot patent auctions shows there is an active market for some intangibles, said Alex Poltorak, chairman and chief executive officer of General Patent Corp., which helps companies license and protect their patents.
 
Nortel Networks Corp. sold its technology patents for $4.5 billion in 2011. That is more than the $3.2 billion it got from the sale of its operating businesses after filing for bankruptcy protection in 2009.
 
That disconnect, Mr. Poltorak said, highlights how “the accounting profession has completely failed modern business in not being able to catch up to new forms of property.”


The Dollar And The Investment Climate

by: Marc Chandler        
              

       
 
Summary
  • The increase in the dollar on a broad-trade weighted basis, is too small to be having the kind of impact many observers claim.        
  • The Fed's Vice Chairman Fischer's comments about the dollar are important, yet most observers ignored them.
  • The critics may shift their focus from China's reserve growth to its surging trade surplus.

The underlying theme in the foreign exchange market is the divergence between the US and UK on one hand and the euro area and Japan on the other. That divergence, however, may not explain the developments in the other capital markets.

The US S&P 500 and the Dow Jones Stoxx 600 in Europe recorded its worst week in a couple of years. US and UK 10-year yields declined by the most this year (~14 bp) and are levels last since in the middle of last year.

Many commodity prices have fallen sharply, and the CRB Index has completed unwound the partly weather-induced gains in the Q1. It has approached the area where it had bottomed last November and this past January. Oil prices have also tumbled. The price of WTI has fallen 10% in the past two weeks. It is still as much as $10 a barrel above where it bottomed in 2011-2012.

Many want to attribute this to the rise of the US dollar. This is deduced from economic theory. A rise in the dollar hurts exports, weighs on earnings of US companies, pressures commodity prices, most still priced in US dollars. All things being equal...

Yet unrecognized by the Financial Times in its "Dollar's relentless rise is beginning to cause headaches", last week, as this price action was being recorded, the dollar lost ground against all the major currencies and many emerging market currencies. Indeed, that, not its "relentless rise" was the real development last week. We do think the dollar is in a long-term uptrend against most of the currencies, the point is that its relationship to other markets is more complicated than often appreciated. Not understanding this will make it more difficult to navigate in this investment climate.

These kinds of stories could be pre-written or written by a robot. The S&P 500 was rallying throughout the dollar's advance. Leave aside the fact that many have been anticipating a pullback because of the over-extended nature of the rally and the historic pattern of weakening during and after the earnings season. As soon as there is a pullback, there is a ready-made story.

The euro peaked in May and sterling in July. The dollar bottomed against the yen early this year and broke out of its four-month two-yen range (~JPY101-JPY103) in late-August. The S&P peaked on September 19. It is true that currency appreciation is tantamount of some tightening of financial conditions. The real issue is how much has the dollar appreciated and how much-tightening financial conditions has taken place.

First, on a broad trade-weighted measure, adjusted for inflation, the US dollar has appreciated 2% since the end of last year. Second, econometric work suggests that a 10% appreciation reduces growth by about 0.4% over the course of a year. If this is true, then one must conclude that the impact on the US economy of the dollar's rise is, thus far, negligible.

Reducing price developments in the markets to the dollar makes real analysis superfluous. It allows one to avoid the complicated story of how there has been a breakdown in discipline within OPEC, and Saudi Arabia is not acting as the swing producer, but instead is boost output and cutting prices. Iran matched these discounts to Asia last week. Alternatively some see a US-Saudi alliance to pressure Russia, though the booming US fracking and shale sector feels it's under attack too.

The bumper US harvest, which goes a long way toward explaining the drop in foodstuff prices, is a function of the agri-business responded to the price signals--high prices previously--and boosting output. For several years now it is China's demand for industrial commodities that seemed to drive prices. Not only has the world's second largest economy slowed, but officials have also cracked down on the use of commodities to disguise capital flows or to back loans. Australian iron ore miners and Chilean copper miners know that the rise in the dollar is not the cause of their woes.

The Fed's references to the dollar were misunderstood. The FOMC minutes give more air time to the wide range of opinions at the central bank. Because of this, we insist it is not the proper medium to understand the Fed's message. Our insight of the importance of the Troika (Yellen, Fischer, and Dudley) illustrates this point. Apparently, few paid much attention to Fischer's comments, but he was clear on October 9 the dollar's rise was "entirely appropriate."

It is true that significant dollar appreciation could become an important headwind, all other things being equal. That is precisely our jobs as investors to recognize that all other things rarely equal and to understand what is different now. Offsetting the tightening impulse that might be emanating for the foreign exchange market is the decline in US interest rates. The decline in US interest rates despite the Fed nearly done with its purchases, is arguably the most significant surprise for investors this year.


It is within this broader context; we share the following six observations about the week ahead.

1. Weak euro area industrial production data is baked in the cake, not only by the PMIs, but more importantly Germany's 4% decline that has already been reported. At the end of the week, new benchmark revisions to GDP for Europe will be announced. The level of GDP is likely to be increased as more activities will be included. The implication for the recent rate of growth is not clear.

2. Eurozone fiscal policy issues may overshadow monetary policy and economic issues in the days ahead. It has already been tipped that the Irish budget (Tuesday) will likely include the closing of a controversial corporate tax loophole. The OECD is pushing hard for countries to end such practices, which have drawn US tech and pharma, among others. In addition, there is likely to be more speculation at the Eurogroup meeting about the French budget. The Wall Street Journal reported last week that France's budget may be rejected by the European Commission, (which is struggling with the European Parliament over Juncker's nominations). Note that with S&P downgrade of Finland before the weekend, now only two euro zone countries remain AAA credits: Germany and Luxembourg. This risks a downgrade of EFSF and ESM facilities.

3. Softer UK inflation and sub-1% earnings growth is likely to reinforce the shift in BOE rate expectations. The implied yield of the March 2015 short-sterling futures contract has fallen 50 bp since early June, from 120 bp to 70 bp last week. Softer economic data, including the housing market, softer inflation, a more defections from the Tories to UKIP encourage speculation that the first rate cut may take place after the May 2015 elections.

4. US data is expected to be mixed and is unlikely to change perceptions of the trajectory of Fed policy. Retail sales are likely to be soft in the headline due to already known information like the slowdown in auto sales and soft gasoline prices. However, the measure used for GDP calculations (excludes autos, gasoline and building materials) should post a healthy increase of around 0.4%. As we have noted before, this is consumption is being fueled out of current income as credit card usage is largely flat. Industrial production, on the other hand, is likely to bounce back after a soft August. Still, there is scope for disappointment, due to the inventory cycle and weakness in foreign markets. Softness in import prices points to a subdued PPI report while the dramatic weakness in equities and Ebola fears may weigh on consumer sentiment.

5. The fall in commodity prices, especially oil prices, may blunt some of the impacts of the weaker yen on Japanese inflation. Producer prices increases are expected to have moderated in September. Excluding the impact of the sales tax increase, there is risk that producer price increases slowed to less than 1% (year-over-year) for the first time since May 2013. While the BOJ's Kuroda says more easing can be delivered if necessary, we suspect it will not be deemed necessary, and that fiscal policy (supplemental budget) will be used to support the economy.

6. China will report September trade balance surplus, reserves, and lending data. The lending data is of passing interest as officials continue to encourage a move to the equity market from shadow banking products. China's reserve growth has been the main evidence for the argument that the yuan is under-valued that officials are preventing it from appreciating. After growing near $500 bln between June 2013 and June 2014, reserve growth is likely to have slowed considerably. The Bloomberg consensus expects PBOC reserves grew by around $20 bln in Q3, sufficient to lift their holdings above $4 trillion, but a marked slowdown nonetheless. This is unlikely to silence China's critics. They will likely shift their attention to the surging trade surplus. Exports are expected to have risen 12% from a year ago, compared with a 9.4% increase in August. Imports may have fallen 2% after a 2.4% decline in August. This will produce a trade surplus a bit below the record $49.84 bln surplus reported in August. The average monthly trade surplus in the 12-months through August was $25.46 bln. In the 12-month period through August 2013, the average monthly trade surplus was $22.05 bln. In the 12-month period through August 2012, the average monthly surplus was $15.24 bln.