EM Contagion & A New Z.1

Doug Nolan

Friday, March 13, 2015

With the (king) U.S. dollar index trading Friday above 100 for the first time since 2003, the unfolding EM - ongoing “global reflation trade” - unwinds broadened and turned more disorderly. Brazil is now lurching toward crisis. Friday trading saw the Brazilian real slammed for 2.6% to the low since April 2003, boosting y-t-d losses to 18.2% (down 27.2% y-o-y). Brazil sovereign CDS surged 13 bps Friday to 302, the high since early-2009. Notably, Brazil’s dollar yields surged 23 bps Friday to a multi-year high 5.08%. For the week, Brazilian (real) yields jumped 43 bps to 13.40% (traded as high as 13.79% intraday Friday).

May 13 – Bloomberg (Filipe Pacheco and Paula Sambo): “Bonds and stocks of Petroleo Brasileiro SA fell after a newspaper reported that the company is in talks with creditors to extend a deadline for publishing audited results and avoid a possible acceleration of payments. Petrobras’s $2.5 billion in bonds due 2024 declined 2.7 cents to 90.55 cents per dollar, the biggest daily drop since Jan. 30. Yields on the notes jumped 0.45 percentage point to 7.74%.

The preferred shares of the company at the center of the nation’s biggest corruption probe slid 2.5%... extending this week’s slump to 10%. The Rio de Janeiro-based oil driller has held negotiations with about 15 banks and investment firms in the past few weeks to extend the deadline, Folha de S. Paulo reported…”
The Bloomberg Commodity Index dropped 3.1% this week to the lowest level since August 2002. This index is now down 44% from 2011 highs. Weakness was notably broad-based. The week saw heating oil hit for 7.3%, coffee 6.7%, lean hogs 6.0%, sugar 5.9%, cocoa 3.8%, cotton 3.4%, natural gas 3.9%, lead 2.3%, nickel 1.7%, silver 2.0%, orange juice 1.5%, corn 1.4% and soybeans 1.2%. With crude (WTI) crushed 9.6% to the low since early-2009, there was notable pressure on EM energy and commodities-related bonds. Troubled Petroleo Brasileiro (Petrobras) CDS surged 70 bps Friday and were up 120 bps for the week to a record 711 bps. 

Vale CDS jumped 55 bps this week to the high since early-2009 (331bps). Markets are increasingly nervous of the major Brazilian lenders, including the state-directed banks. Banco do Brasil CDS jumped 62 bps this week to 442 bps. Brazilian development bank BNDES CDS jumped 48 bps. It’s also worth mentioning that Petroleos Mexicanos CDS jumped 24 bps to 207 bps.

Venezuela dollar yields jumped 66 bps Friday and were up 220 bps for the week to 28.65%. Pricing imminent default, Venezuela CDS surged 1,294 bps this week to 5,506 bps. Colombia CDS jumped 21 bps to 175 bps, Peru 22 bps to 145 bps, and Panama 20 bps to 149 bps. Jumping 20 bps, Mexican CDS this week traded to the highest level since July 2013 (136 bps)

EM currency weakness was broad-based. In Latin America, the Brazilian real this week fell 5.7%, the Colombian peso 3.2% and the Chilean peso 1.8%. Eastern European currencies were under heavy pressure. The Polish zloty was hit for 3.6%, the Bulgarian lev 3.2%, the Hungarian forint 3.2%, the Romanian leu 3.2%, the Czech koruna 3.1% and the Iceland krona declined 2.4%. The Russian ruble reversed course and declined 2.9% this week.

EM bonds were also under pressure. The lira’s 1.9% Friday decline wiped out the Turkey currency’s earlier rally, as Turkish lira yields jumped 14 bps this week to a three-month high 8.36%. Turkey CDS traded to an almost one-year high earlier in the week. In Asia, Indonesia CDS rose 12 bps to a two-month high 160 bps. Interestingly, China CDS gained 5 bps to 89 bps.

EM stocks were not spared. Russian stocks were hit for 5.8% and Turkish equities were slammed for 4.6%. India’s Sensex index fell 3.2%. Brazil's Bovespa declined 2.8%.  Eastern European equities were under pressure almost across the board. Things were not much better in Latin America and Asia.

The euro was slammed for 3.2% this week, trading to the lowest level versus the dollar since 2002. Greek five-year yields surged 329 bps to 15.15%. Greek CDS jumped 350 bps to 1,708 – not far from the highest levels since 2012.

The Federal Reserve released its Q4 Z.1 “flow of funds” report Thursday. 

Total Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized (SAAR) rate of $1.938 TN, the strongest growth since Q4 2012. Total Business borrowings expanded SAAR $845bn, up from Q3’s SAAR $581bn to the highest level since Q1 2008. Federal government borrowed at SAAR $700bn, down from Q3’s SAAR $913bn. Total Household borrowings increased SAAR $361bn, little changed from Q3.

For all of 2014, NFD expanded $1.701 TN, up from 2013’s $1.463 TN. With 2014 federal borrowings ($667bn) about half the 2012 level, 2014 NFD growth somewhat lagged 2012’s $1.828 TN. Yet 2014 Household borrowings of $376bn were up significantly from 2013’s $197bn to the highest level since 2007 ($913bn). Total 2014 Business borrowings of $672bn were up from 2013’s $546bn to the strongest growth since 2007 ($1.116 TN).

On a percentage basis, NFD expanded 4.3% in 2014, up from 2013’s 3.8%. Business debt growth accelerated to 7.2% from 2013’s 5.0%. Although mortgage debt growth remained below 1%, total Household borrowings increased 2.9%. Outstanding State & Local borrowings contracted 0.5% in 2014.

Bank Credit growth slowed during Q4, with Banking Assets expanding $954bn during 2014, or 6.0%. Bank loans, however, posted another strong quarter, with notable 2014 growth of 12.3% ($308bn). For the year, Credit Union assets expanded 5.9%, REIT liabilities 8.3%, and Security Credit 7.7%. A significant Q4 decline pushed Securities Broker/Dealer Assets to a 4.5% 2014 contraction.

Despite only modest growth from most traditional sources of system Credit, inflationary forces continue to buttress securities markets. My proxy for “Total Debt Securities” – Treasuries, Agency Securities, Corporate Bonds and Muni debt – increased $1.25 TN during 2014 to a record $36.15 TN. Total Debt Securities have increased $8.075 TN, or 29%, since the end of 2008. Total Equities have jumped $20.816 TN, or 133%, since 2008. 

As such, my proxy of “Total Securities” jumped $4.08 TN in 2014 to a record $72.608 TN. Total Securities have increased $28.9 TN since the end of 2008, or 66%.

“Total Securities” as a percentage of GDP is helpful Bubble Analysis. After beginning the nineties at 173% of GDP, “Total Securities” ended the Bubble year 1999 at an unprecedented 341%. The bursting “tech” Bubble saw this ratio decline to 267% to end 2002. Mortgage finance Bubble reflation then pumped this ratio to a record 360% by the end of 2007. 

This Bubble burst, and “Total Securities” ended 2008 at 297% of GDP. Six years of incredible monetary inflation had Total Securities ending 2014 at a record 417% of GDP.

I have on a quarterly basis chronicled the inflation of Household sector Net Worth as a key facet of Federal Reserve reflationary policies. Household Assets inflated another $1.61 TN during Q4, with a 2014 gain of $4.431 TN. For the year, Household Real Estate assets increased $1.223 TN and Financial Assets rose $3.045 TN. 

And with Household Liabilities growing $363bn, Household Net Worth (assets minus liabilities) jumped another $4.068 TN in 2014 to a record $82.912 TN. Since the end of 2008, Household Net Worth has inflated $26.403 TN, or 47%. This “wealth creation” goes a long way in explaining the economic recovery – as well as its vulnerability to asset market weakness.

As a percentage of GDP, Household Net Worth began the nineties at 379% ($21.5 TN). Net Worth rose to 446% ($43.1 TN) of GDP to end 1999, only to fall back down to 398% ($43.7 TN) to close 2002. Net Worth inflated to a record 461% ($66.7 TN) to end 2007. Household Net Worth closed 2014 at a record 476% of GDP ($82.9 TN).

Federal Reserve Asset growth slowed to $48bn during the quarter, with 2014 growth of $482bn, or 11.8%. Amazingly, the Fed’s balance sheet inflated $1.601 TN, or 54%, over the past two years. And since the end of 2007, Fed liabilities have inflated $3.604 TN, or 379%.

Curiously, GSE borrowings (debt as opposed to MBS) expanded SAAR $316bn during Q4, the most rapid GSE growth in years. Is the GSE ramp up coincident with the wind down of Fed QE? The GSEs posted three straight quarters of strong growth. As hard as it is to believe, GSE activities should be monitored closely in 2015.

Overall, 2015 is destined to be a fascinating and challenging year for macro Credit and flow analysis. After six years of extraordinary monetary stimulus, the U.S. asset markets and Credit system have attained a degree of momentum. Thus far, the (temporary?) conclusion of Fed QE has had little apparent liquidity impact. I believe ongoing liquidity abundance owes much to global “hot money” flowing into (hot) king dollar securities markets. Faltering Bubbles at the Periphery have incited self-reinforcing robust flows to the “Core.” 

But as bursting EM Bubble contagion now gathers momentum, there’s potential for a more globalized Risk Off dynamic to surprise U.S. markets with a bout of destabilizing de-risking and de-leveraging. This week did see a modest widening of Credit spreads. I continue to believe a reversal and strengthening yen would likely spur more aggressive speculative de-leveraging.

Up and Down Wall Street

Global Markets vs. Reality: The Great Divide

While global economies struggle, the financial markets generally stay strong.

By Randall W. Forsyth           

March 13, 2015 9:27 p.m. ET

The world is more important to America than America is to the world.
That observation is not original but has never seemed more apt. This state of affairs has both geopolitical and economic roots. On the former, I have definite opinions, but I can’t say they’re worth more than what’s offered from the next bar stool, and, moreover, I am well aware that they’re not why you’ve parted with the price of this peerless weekly.
As for the relevant topic at hand, the U.S. financial markets and economy are subject to global influences to an extent arguably not seen for a century or more. Specifically, the exchange rate of the dollar is affecting securities markets in ways not familiar to most Americans.
To be sure, there have been episodes when a weak greenback has caused all sorts of pain, from the stagflation of the 1970s to the stock market crash of October 1987. And the greenback’s slide in the wake of aggressive easing actions by the Federal Reserve following the 2008 financial crisis gave rise to questions of whether it would remain the world’s dominant currency for transactions and as a store of value, along with complaints that the U.S. was cheapening the dollar to gain a trade advantage.
Now, we are seeing the flip side. One would think, just as one can’t be too rich or too thin, that one’s currency can’t be too strong. There could be steep costs, as in the 1980s, when the super-muscular greenback largely was the product of double-digit interest rates engineered by the Volcker Fed. That was cured easily and painlessly with rate cuts.
Now, however, the Yellen Fed is merely contemplating lifting its interest-rate target from the nearly irreducible 0% to 0.25% that has prevailed since the crisis days of December 2008. (I will leave aside compare-and-contrast questions about the fiscal and regulatory policies of three decades ago and the present.)
To make sense of this new world—not necessarily a brave one—we consulted someone with unsurpassed global knowledge and insights: our Barron’s Roundtable veteran, Felix Zulauf, president of Zulauf Asset Management and co-chief investment officer and partner of Vicenda Asset Management in Zug, Switzerland. When I caught up with him last week, he had just gotten back from a five-week excursion to the far reaches of the Southern Hemisphere, including, most spectacularly, Antarctica. Despite having been so recently at the ends of the earth, Felix had his sights set firmly on the global situation.
When the Roundtable gathered in January, he perceived that the dollar would be rising in what he termed a global short-covering rally. To explain, the Fed’s massive quantitative easing resulted in even more massive borrowing abroad of the dollars the U.S. central bank had created. That observation was corroborated in a report by the Bank of International Settlements, the putative central bank for central banks, that non-U.S. borrowers had increased their dollar indebtedness by some 50% since the financial crisis, to $9 trillion from $6 trillion.
Following this credit boom outside of the U.S., the Fed ended QE and is contemplating its first interest-rate hike. And as the Bank of Japan and the European Central Bank are engaging in their own quantitative easing, pushing the greenback higher against the yen and euro, these dollar debtors are getting pressured by the prospect of having to pay back their loans in dearer dollars. In trading parlance, it’s a classic short squeeze.
For the medium-to-long term, Felix thinks the dollar’s rally has a lot further to go, likening it to the bull markets of the 1980s and 1990s. For the near term, however, the extreme move in the greenback that has grabbed the media’s attention is likely to pause or correct, given the huge long positions that have been amassed by traders.
But, he emphasizes, these moves are based on fundamentals. The dollar is strong because growth is flagging in Japan, Europe, and the emerging markets. As for the U.S., he sees growth stuck around 2%, at best, rather than “normalizing” in the 3% to 4% range.
“The function of the currency markets is to reallocate growth,” Felix explains. The weak dollar that followed the Fed’s QE boosted U.S. growth, which will be reallocated to other parts of the world. But as the buck rises, the decline in the euro and the yen raises the danger of “real, serious deflation” as the euro-zone nations and Japan use their cheaper currencies to grab a bigger piece of the global trade pie, which is expanding sluggishly.
What these monetary machinations point up is the wide divide between the real economies and the financial markets, Felix emphasizes. The central-bank bond purchases haven’t significantly spurred bank lending in the absence of real credit demand. Instead, banks have plowed money back into bonds, driving down yields, spurring further “recycling” of the money by investors into stocks.
As a result, he continues, European equities now are priced on the basis of the negative interest rates that prevail on upward of $2 trillion worth of euro-zone government securities (depending on their yields and prices on any particular day). Relative to U.S. equities, European stocks’ valuations are higher than they were in 2007, he adds. That has been a result of the headlong rush into European equities, including by way of U.S.-listed exchange-traded funds.
In the U.S., Felix thinks stocks could make “marginal new highs” but are subject to a significant 10% to 15% correction sometime in the late spring or summer, or perhaps into the fall, somewhat later than he previously expected. That is the likely outcome as the two separate worlds of the real economy and the financial markets spin further apart.
HOW MUCH ALL OF THIS will matter to the Federal Open Market Committee when it gathers this week is unknown. We’ll have a better idea after the panel’s decision is announced on Wednesday afternoon and Fed Chair Janet Yellen explicates it in her press conference afterward.
The focus, nay, the obsession of market watchers is whether a single word, “patient,” will be removed from the policy announcement. According to the way the Fed is supposed to signal its intentions, the excision of that word would open up the possibility of a rate hike at the June 16-17 FOMC confab.
Some economists contend that the dollar’s rise should have minimal impact on the Fed’s decision, because the U.S. economy is relatively “closed,” with a smaller proportion of gross domestic product involving trade than in other nations. By that standard, exchange rates don’t matter all that much.
For the Standard & Poor’s 500 companies, however, it’s a different story, as some 40% of the earnings of these mostly multinational companies come from abroad. So, once again, this obsession with the dollar could be an example of the divide between the financial markets and the real economy. And by that criterion, the Fed would do well to consider signals from the latter and begin the process of lifting its rate target from near zero.
But, given the growing signs of weakness at home and abroad, hiking rates in the near term would make the folks at the Fed a bunch of “blockheads,” contends Jeffrey Gundlach, the head of the DoubleLine asset-management complex. Gundlach’s views became the buzz of the market when they were discussed a few months ago in this space by my learned colleague, Jon Laing. Gundlach’s characterization also likely raised more than a few eyebrows after he let loose in his conference call to investors last week.
Other, more circumspect institutional investors invoked precedents of past policy blunders. Most notable was that of 1937, when the Fed tightened monetary policy by effectively draining the excess bank reserves it had created, out of fear that the surfeit of liquidity would create inflation or push up asset prices excessively.
So, after a partial recovery from the devastation of the early 1930s, the central bank (with the help of tax increases and spending cuts on the fiscal side) managed to create the second down leg of the Great Depression.
History may not repeat, but as Mark Twain famously observed, it does tend to rhyme. One contingent at the Fed contends that the ideal time for the central bank to have hiked rates was last year. The fall in the unemployment rate to 5.5%, they argue, signals that the slack is out of the labor market and that crisis-level zero-interest rates are no longer appropriate.
By the same token, the Fed’s other policy measure, inflation, remains far below its 2% target. That’s even after ignoring the 0.5% fall in the producer price index for February, which the lynx-eyed Joshua Shapiro, chief U.S. economist at MFR, pointed out was “massively distorted” by “foolish” seasonal adjustments.
In any case, the stock market is acting as if the Fed will follow through and initiate its rate-increase campaign in June. The Dow Jones Industrial Average shed another 146 points on Friday, which was about half of its loss at the session’s low, amid concerns as the dollar spiked to a 12-year high against the euro.
Closer to home, and perhaps more relevant to U.S. businesses competing with our closest trading partners, the Canadian dollar fell to a six-year low, while the Mexican peso languishes near a historic nadir. Meanwhile, oil’s bounce appears short-lived, with U.S. benchmark crude ending on Friday at $47.30 a barrel, a six-week low, amid bulging inventories.
So, could the Fed signal the possibility of the first rate hike amid the deflationary effects of the rising dollar and falling commodity prices, not to mention tepid wage gains? Do government officials ever commit blunders? The question contains its own answer.


Mario’s miracle?

European monetary policy has boosted stockmarkets and weakened the euro

Mar 14th 2015

ONCE again Mario Draghi, the president of the European Central Bank, is living up to his “Super Mario” nickname. In 2012 he stabilised markets with his pledge to do “whatever it takes” to save the euro. This year he has pulled off a similar trick by adopting quantitative easing—the printing of money to buy assets. This week the ECB started buying government bonds; it was already snapping up asset-backed securities and covered bonds.

The announcement of QE in late January helped revive investor sentiment after a tricky start to the year. Global stockmarkets rose by 5.3% in February, according to Standard & Poor’s, with four in the euro zone (Austria, Greece, Portugal and Ireland) posting double-digit gains.

Easier monetary policy is not the only factor behind the rally. Investors were relieved when Greece and its creditors agreed on a four-month extension of its loan programme. That reduced the risk of a Greek exit from the euro zone (although Greece’s financial health remains poor).

The sharp fall in the oil price has also acted as a tax cut for European consumers, adding to hopes that the continent’s economy is escaping from the doldrums. Citigroup’s economic-surprise index for the euro zone, which reflects whether data have underperformed or beaten expectations, has jumped from -57.3 in mid-October to +49.5 on March 9th. The ECB has raised its growth forecast for the current year from 1% to 1.5%; the OECD says it sees “tentative signs of a positive change in growth momentum in the euro area”.

No one expects the kind of growth that would make the Chinese envious. But the recent data come in the context of years of unrelenting gloom, when investors seemed to doubt that the euro zone would ever grow at all.

Further positive news has come from the European banking sector. Since 2008 banks have focused more on strengthening their balance-sheets than on lending to companies. This credit squeeze was bad for growth. But things have been picking up. The broad measure of money supply (M3) grew by 4.1% in the year to January; 12 months earlier, the annual growth rate was just 1.2%. M1, a narrower measure, bears out the trend: its growth has jumped from 6.2% to 9% over the same period.

Large companies have also been able to take advantage of very low yields in Europe’s bond markets.

The ECB has played a role here too: investors have anticipated the launch of QE by driving government-bond yields sharply lower. The yields on two-year bonds in France, Germany and the Netherlands, among others, are negative. Germany’s ten-year bonds yield is just 0.23%, which means it has replaced Japan as the world’s lowest-cost borrower.

That has prompted return-chasing investors to pile into corporate debt; the yield on the bonds of Nestlé, a Swiss foods group, has gone negative as well. European companies have not been alone in taking advantage. In the first two months of the year, American companies issued over €18 billion ($19 billion) of euro-denominated debt, a 160% increase on the same period in 2014.

Coca-Cola alone sold €8.5 billion of bonds. Investors submitted €20 billion of orders for them, even though the firm was offering yields as low as 1.65% on 20-year bonds.

The rest of the world may not be quite so positive about another consequence of the ECB’s action: the sharp fall in the euro (see chart). It dropped below $1.06 on March 11th, its lowest level since early 2003. That is not just a matter of euro weakness; the dollar has been rising against the yen as well, as investors anticipate that, later this year, the Federal Reserve will push through the first rate rise since the financial crisis. The dollar is now at its highest level against major currencies, in trade-weighted terms, since 2003.

That matters for America’s exporters. Although its trade deficit is still benefiting from rising domestic production of shale oil and gas, the non-oil trade deficit was nearly $50 billion in January, more than $10 billion above the same month last year. And the profits of American companies suffer when foreign earnings are translated into dollars; estimates for profits growth this year have been revised down from 9.1% to 2.1% in recent months.

If European QE is to be positive for the world, rather than just the euro zone, then it has to revive demand, not merely grab market share on behalf of the continent’s exporters. The example of Japanese QE is rather patchy in this respect: three of the past five quarters have seen a decline in economic activity (although the effect is obscured by a rise in the consumption tax). Investors clearly have faith that Super Mario’s plan will work better.

The Death of the Euro?

By: David Chapman

Thursday, March 12, 2015

Death of the Titanic
Artist: Matthew Chapman from Matthew Chapman's Titanic Tribute 100 years, an exhibition of paintings, drawings and installations. The Arts & Letters Club of Toronto, April 7-12, 2012. With the permission of the artist. Copyright 2015.

Is the Euro the Titanic? The question may be rhetorical but oddly, there are comparisons.

The Euro "set sail" on January 1, 1999 to great fanfare as it replaced the European Currency Unit (ECU) which was a basket of the currencies of the European community (EU). Up until the Euro came into being, the members of the EU continued to use their national currencies. The ECU was an accounting unit only. Only 19 of the 28 EU members use the Euro as currency.

Two of the most notable exceptions of EU members who do not use the Euro are Great Britain who continues to use the British Pound and Sweden who uses the Swedish Krona. The Euro is also used by the institutions of the EU as well as four mini states that all lie within Europe (Andorra, Monaco, San Marino and Vatican City).

Euro Chart

One could argue that the Euro hit the "iceberg" in April 2008. That was the peak at 1.5980.

The financial panic of 2008 saw a rush into the US$ as a safe haven but as 2009 got underway the Euro began to climb again as everyone believed that while there was some rough times ahead the worst of the crisis was over. But the Euro zone was developing too many systemic problems. The population was aging, the birthrate was stagnant, and immigration was a problem primarily because immigrants were for the most part poorly integrated into the broader population. In addition, the EU has too many regulations coupled with a rigid labour market and overly large public sectors. The EU itself is a centralized bureaucracy with a number of different councils, commissions and agencies. The EU is governed by an elected Parliament with the number of seats each country gets is based on population.

Germany, France, Italy and Britain dominate the European parliament.

But what really dragged the Euro zone down was failure to consolidate all of the member's debt. While they created a central bank, the ECB, central banks that had been an integral part of each individual member not only continued to function they could continue to act as a central bank. The central bank of each country in the EU is member and shareholder of the ECB. Once again, Germany, France and Italy dominate the ECB as the largest economies. The Bank of England (BOE) is not a member because Britain does not use the Euro.

The ECB is responsible for monetary policy for the zone but does not have the powers of the US's Federal Reserve. The financial strength of each country varied sharply from strong countries like Germany, France and Britain to weaker countries like Greece, Portugal and eventually the eastern European countries that joined the Euro zone later following the collapse of the Soviet Union.

The EU and the Euro currency are dominated by Germany and to a lesser extent by France and Italy. Britain is also a dominate economy as a member of the EU but Britain does not use the Euro as currency. Germany as the dominate economy, effectively uses the rest of the EU to export its goods to. Using the Euro Germany received the equivalent of a devaluation of its former currency the Deutschemark. Not so for many smaller peripheral countries where the switch to the Euro meant effectively a huge appreciation of their currencies.

Strong export countries like Germany, Italy, the Netherlands, Sweden, Norway and Denmark thrived while others in an attempt to catch up to the standards of the stronger European economies borrowed money when what was needed was huge structural reform.

The Eurozone crisis or the Euro crisis as some refer it got underway at the end of 2009. The crisis is also referred to as the European sovereign debt crisis. After piling up huge loans without the accompanying structural reforms to their economies and suffering the after effects of the 2008 financial panic a number of EU states were unable to either repay or finance their debt without a bailout from the ECB, the IMF and the EU commission. These three were nicknamed the "Troika".

The states faced sharply rising interest rates, huge structural deficits, and mostly a high debt to GDP ratio. The countries most impacted became known as the PIGS (Portugal, Ireland, Greece and Spain).

Others soon joined them (Cyprus, Italy). Of late I have been reading that Austria could be the next Greece.

The Euro's "sinking" phase was underway from 2009 to 2014. Whenever the ongoing Euro crisis appeared difficult to resolve the Euro fell. When short-term solutions appeared to be found the Euro rose. Interest rates were lowered, refinancings took place, countries had to undergo structural reform and austerity in order to try to stabilize themselves.

Contagion also spread as Italy and some of the smaller peripheral eastern European states began to suffer as well. Eventually even France was coming under pressure as the French economy has shown signs of sliding into recession.

The Euro zone is falling into deflation. Consumer prices have turned negative in a number of Euro zone countries. A number of countries have moved to negative interest rates. There is an estimated $1.7 to $2 trillion worth of bonds in the Euro zone trading at negative yields. Even German bonds are trading at negative yields. None of this is a positive development and suggests that the Euro has considerable further to fall.

Politically Greece and the risk of the "Grexit" is not the EU's major potential problem any longer. Polls show that a referendum on Great Britain remaining in the EU could fail. The British Pound has been hit hard on this news. It has raised talks of the "Brexit".

But could there also be the "Frexit"? Ok I haven't actually seen that term as I just made it up ("Frexit" - France exit from the EU and the Euro). In France, the xenophobic far right National Front headed by Marine Le Pen is leading in the polls and could form the next government. The National Front wants to pull France out of the EU and the Euro and return to the French Franc. There are a number of nationalist right wing parties in Europe and many of them are anti EU and Euro. All have been gaining in popularity.

The Euro began its "death" spiral back in March 2014 when it topped at 1.3950. Today the Euro is trading under 1.06 and falling. The decline has been rapid and appears to be picking up speed. The Euro formed what appears as a descending triangle pattern prior to the collapse. The triangle pattern suggests that the Euro has the potential to fall to objectives at 0.82. That is still another 24% from current levels.

There are many saying that the Euro is doomed. That may be. Forecasts for the end of the Euro range anywhere from 2018 to 2022. If the Euro were to collapse because of countries exiting the EU and the Euro it would go down as one of largest currency collapses in history. What the cost to the EU and the Euro zone plus fall out to other countries and global markets is unknown.

But the collapse of a currency such as the Euro cannot be idly dismissed. Other currencies have collapsed such as Zambia and Zimbabwe. But their impact was largely local. The Venezuelan Bolivar could well be headed for collapse as well. Its collapse could be felt beyond Venezuela.

A collapse to 0.82 would not be the end of the world for the Euro. In 1985, the adjusted Deutsche Mark expressed in Euros fell to the equivalent of 0.58. That set up the Plaza Accord of September 1985 to bring down the high value of the US$. The new introduced Euro fell to near 0.83 in July 2001. And that was not long after the introduction of the Euro in January 1999.

Given negative interest rates in the Euro zone it should not be a surprise that Euros are being sold for US$. The question is where are the US$ going? The US stock market and bonds have both been falling of late. While gold prices have fallen roughly 3% in US$ so far in 2015, gold is up over 10% in Euros. Gold is also up just under 7% in Cdn$, just over 1% in British Pounds and flat in Japanese Yen. Gold in Russian Rubles is surprisingly flat so far in 2015 but remains roughly doubled from where it was on December 31, 2013.

The Euro has support at 1.05 and 1.00. But a breakdown under 1.00 could start a panic. The simple reality is that the Euro zone remains a mess with too many countries struggling to meet their debt obligations if even they can. Couple this with the desire of some to exit the EU and leave the Euro.

No matter what the ECB does to try and mitigate this, events could potentially overwhelm the central bank. The central bank wants to inflate and instead they are getting deflation.

Meanwhile the US$ continues to soar and already there is considerable grumbling in the background. The sharply rising US$ is hurting exports and it is negatively impacting the profits of its multinationals as they have over half their earnings in foreign countries. A rising US$ rather than exhibiting strength is most likely signaling coming deflation in the US as well.

Already recent PPI and CPI releases have turned negative. And despite the so-called strong jobs report numerous other economic numbers are actually sliding. The US's two main competitors, Europe and Japan are both sliding into recession and deflation. China is slowing and they have a very vulnerable banking system. The US is not immune. The US$ most likely has further to rise before there are cries to bring it down. That has happened before in 1985 and 2001. Should this time be different?

The Euro is slowly dying. It has been a slow death. Like the Titanic, it initially appeared to not be a problem and assurances were given that things were under control. But eventually the people on the Titanic realized that the ship was going to sink. It was at that point that the panic began. The recent collapse of the Euro is a signal that things are not under control and indeed could be getting worse. The death of the Euro? It remains possible given everything that is developing or underway. But like the Titanic the real panic will not hit until towards the end.

The Titanic's end came swiftly? Will the Euro do the same?


The Problem Is Bigger Than Ferguson


MARCH 12, 2015

Ferguson, Mo., on Thursday. Credit Michael B. Thomas/Getty Images                    

The Justice Department’s exposé of the bigoted law enforcement practices at play in Ferguson, Mo., has rightly led to an exodus of officials from the town government. In the week since the report was made public, the police chief, the city manager and the municipal court judge have all stepped down, and the city’s court has been placed under state supervision.
The situation took a tragic turn early Thursday morning when two police officers were shot and wounded during a demonstration. Police officials should not use the shootings as an excuse to clamp down on legal, peaceful demonstrations. That would only inflame tensions, making the climate worse. 

The housecleaning among the political leadership in Ferguson is a necessary step. But the illegal and discriminatory measures uncovered by the Justice Department are not limited to that troubled municipality. Indeed, the evidence strongly suggests that Ferguson is not even the worst civil rights offender in St. Louis County and that adjacent towns are also systematically targeting poor and minority citizens for street and traffic stops to rake in fines, criminalizing entire communities in the process.
St. Louis County has some 90 municipalities, some of which get 40 percent or more of their revenue from traffic fines and fees from petty violations. Drivers can pass through several towns in just a few miles on a single road. Those detained in one town are often dragged through the courts or jails of other communities. At the moment, civil rights lawyers are suing nearly a dozen towns either for illegally jailing people who are too poor to pay fines or for assessing fines and fees that lawyers allege are illegal to begin with.
An especially striking class action suit has recently been filed against the city of Jennings, which shares a border with Ferguson. It charges the city with violating the Constitution by jailing indigent defendants because they are unable to pay the fines associated with minor violations.

Instead of being allowed to make affordable payment arrangements, the complaint says, these impoverished plaintiffs were “threatened, abused, and left to languish in confinement at the mercy of local officials until their frightened family members could produce enough cash to buy their freedom or until city jail officials decided, days or weeks later, to let them out for free.”
The plaintiffs say they have been held in filthy cells smeared with mucus, blood and feces and sometimes kept in the same dirty clothing for weeks. In each of the last two years, the complaint says, “inmates have committed suicide in the Jennings jail after being confined there solely because they did not have enough money to buy their freedom.” Lawyers allege that one plaintiff, a grandmother, was illegally held in the Jennings jail at least 19 times. She fears that she could be arrested at any time and hauled back in.
Ferguson’s perverted system of justice is not unique in the county. The Justice Department’s top civil rights prosecutor, Vanita Gupta, made that point last week when she said that “Ferguson is one dot in the state, and there are many municipalities in the region engaged in the same practices a mile away.”
She added that “it would be a mistake for any of those neighboring jurisdictions to fold up their hands. They should absolutely take note of this report.” The Justice Department may need to sue other towns with bad records and join some of the pending lawsuits to make this point.
As for Ferguson, the police department has clearly broken the trust of the city it is supposed to serve.
One way to solve that problem is to dissolve the department and hand the policing function over to the county itself. But cleaning up that one town won’t necessarily help its residents if they continue to be ensnared in the deplorable justice systems operating elsewhere in St. Louis County.

WTI Will Retest $43 As Oil Supplies Continue To Climb

By Sumit Roy

It's becoming increasingly likely that WTI will challenge the six-year low set in late January.
The Department of Energy reported this morning that in the week ending March 6, U.S. crude oil inventories increased by 4.5 million barrels, gasoline inventories decreased by 0.2 million barrels, distillate inventories increased by 2.5 million barrels and total petroleum inventories increased by 2.5 million barrels.

Crude oil was a mixed bag following the release of the latest inventory figures, with Brent rising and WTI falling. However, both benchmarks have declined during the past week, as bloated inventories and ever-rising U.S. production weigh on the market.



In our view, it's increasingly likely that WTI will retest its cycle just above $43 as U.S. inventories continue to mount. On the other hand, with Brent more than $11 above its cycle low of $45, the European benchmark looks safe for now. It could certainly decline from here, but it would take a very bearish development in the market to push prices for that benchmark to new lows.

Of course, if oil stockpiles continue to surge and storage capacity runs out, all bets may be off and prices could fall precipitously. That's what Ed Morse, head of commodity research at Citigroup, thinks will happen. In an interview with HardAssetsInvestor earlier this week, Morse told us that prices may fall as low as $20 to force shut-ins of production once inventories completely fill.

That's similar to an argument we made late last year. That said, it's very uncertain whether such a scenario will come to pass or whether the market will tighten quickly enough to prevent it. In the very short term, any bullish response will have to come from the demand side, because it's quite clear that supply is not responding yet.

Turning to this week's EIA inventory figures, total petroleum inventories in the U.S. increased by 2.5 mmbbl, against the five-year average of a 3.8 mmbbl decrease. In turn, the inventory surplus increased to 135.3 mmbbl, or 12.9 percent, against the five-year average.

Crude oil inventories rose by 4.5 mmbbl, against the five-year average of a 2.7 mmbbl increase. In turn, the surplus in the crude category widened to 89.7 mmbbl, or 25 percent.

Regionally, inventories inside and outside the Midwest rose.

Gasoline inventories fell by 0.2 mmbbl against the five-year average of a 3.2 mmbbl decrease.

Gasoline inventories now have a surplus of 14.2 mmbbl, or 6.3 percent. Distillate inventories rose by 2.5 mmbbl against the five-year average of a 1.8 mmbbl decrease. In turn, the distillate deficit narrowed to 8.5 mmbbl, or 6.3 percent.



Total petroleum demand in the U.S. dropped to 18.6 mmbbl/d, while gasoline demand fell to 8.5 mmbbl/d and distillate demand fell to 3.8 mmbbl/d. On a four-week rolling basis, total demand was up by 5.5 percent from last year. On that same basis, gasoline demand was up 2.8 percent and distillate demand was up by 12.8 percent.

It's worth noting that these figures may be overstated due to the EIA's methodology for calculating demand.


Crude oil imports fell by 0.6 million barrels per day to 6.8 mmbbl/d. On a four-week rolling basis, imports have averaged 1.2 percent below the year-ago level.

Refinery Activity

Refinery utilization ticked up from 86.6 percent to 87.8 percent. Utilization is above the year-ago level and above the five-year average. Gasoline production fell to 9.2 mmbbl/d, while distillate production rose to 4.8 mmbbl/d.


U.S. crude oil production increased to 9.37 mmbbl/d, a new multidecade high. Output has been rising swiftly due to surging production in unconventional oil plays. Since the start of the year, output has averaged 1.1 mmbbl/d, or 14 percent, above the same period a year ago.

Inventories at the Nymex delivery point in Cushing, Oklahoma, rose by 2.3 million barrels to 51.5 million barrels, or 60.7 percent of the EIA's estimate of capacity. Overall, Midwest inventories rose by 1.6 million barrels to 134.9 million barrels, or 81.2 percent of estimated storage capacity.

Front-month WTI calendar spreads remained in contango at +$1.78.

Front-month Brent calendar spreads remained in contango at +$0.48.

West Texas Intermediate's discount to Brent decreased week-over-week from -$9.77 to -$9.05. WTI's discount to Louisiana Light decreased week-over-week from -$6.35 to -$5.25.

The Baker Hughes oil rig count decreased by 64 to 922 rigs last week.

Baker Hughes Oil Rig Count

Gaming a Russian Offensive



Editor's Note: As part of our analytical methodology, Stratfor periodically conducts internal military simulations. This series, examining the scenarios under which Russian and Western forces might come into direct conflict in Ukraine, reflects such an exercise. It thus differs from our regular analyses in several ways and is not intended as a forecast. This series reflects the results of meticulous examination of the military capabilities of both Russia and NATO and the constraints on those forces. It is intended as a means to measure the intersection of political intent and political will as constrained by actual military capability. This study is not a definitive exercise; instead it is a review of potential decision-making by military planners. We hope readers will gain from this series a better understanding of military options in the Ukraine crisis and how the realities surrounding use of force could evolve if efforts to implement a cease-fire fail and the crisis escalates.

Russia's current military position in Ukraine is very exposed and has come at a great cost relative to its limited political gains. The strategic bastion of Crimea is defensible as an island but is subject to potential isolation. The position of Ukrainian separatists and their Russian backers in eastern Ukraine is essentially a large bulge that will require heavy military investment to secure, and it has not necessarily helped Moscow achieve its larger imperative of creating defensible borders. This raises the question of whether Russia will take further military action to secure its interests in Ukraine.

To answer this question, Stratfor examined six basic military options that Russia might consider in addressing its security concerns in Ukraine, ranging from small harassment operations to an all-out invasion of eastern Ukraine up to the Dnieper River. We then assessed the likely time and forces required to conduct these operations in order to determine the overall effort and costs required, and the Russian military's ability to execute each operation. In order to get a baseline assessment for operations under current conditions, we initially assumed in looking at these scenarios that the only opponent would be Ukrainian forces already involved in the conflict. 


One of the most discussed options is a Russian drive along Ukraine's southern coast in order to link up Crimea with separatist positions in eastern Ukraine. For this scenario, we assumed that planners would make the front broad enough to secure Crimea's primary water supply, sourced from the Dnieper, and that the defensive lines would be anchored as much as possible on the river, the only defensible terrain feature in the region. This would in effect create a land bridge to secure supply lines into Crimea and prevent any future isolation of the peninsula. Russia would have to drive more than 400 kilometers (250 miles) into an area encompassing 46,620 square kilometers, establish more than 450 kilometers of new defensive lines, and subdue a population of 2 million.

Taking this territory against the current opposition in Ukraine would require a force of around 24,000-36,000 personnel over six to 14 days. For defensive purposes, Russian planners would have to recognize the risk of NATO coming to Kiev's assistance. Were that to happen, Russia would have to expand the defensive force to 40,000-55,000 troops to hold the territory.

Planners must also consider the force needed to deal with a potential insurgency from the population, which becomes decidedly less pro-Russia outside of the Donbas territories.

Counterinsurgency force structure size is generally based on the size of the population and level of resistance expected. This naturally leads to a much wider variance in estimates. In this scenario, a compliant populace would require a force of only around 4,200 troops, while an extreme insurgency could spike that number to 42,000. In this particular case, no extreme insurgency is expected, as it would be in cities such as Dnepropetrovsk, Kharkiv or Kiev. The defensive force could overlap with the counterinsurgency force to some degree if there were no external threat, but if such a threat existed the forces would have to be separate, potentially doubling the manpower required to secure the territory.
A similar scenario that has been considered is the seizing of the entire southern coast of Ukraine in order to connect Russia and its security forces in the Moldovan breakaway region of Transdniestria to Crimea. The logic goes that this would cripple Kiev by cutting off access to the Black Sea and would secure all of Russia's interests in the region in a continual arc. In terms of effort required, Russia essentially would be doubling the land bridge option. It would require an attacking force of 40,000-60,000 troops driving almost 645 kilometers to seize territory encompassing 103,600 square kilometers over 23-28 days. The required defensive force would number 80,000-112,000. This would also add a complicated and dangerous bridging operation over a large river. Moreover, the population in this region is approximately 6 million, necessitating 13,200-120,000 counterinsurgency troops.

These first two scenarios have a serious flaw in that they involve extremely exposed positions. Extended positions over relatively flat terrain — bisected by a river in one scenario — are costly to hold, if they can be defended at all against a concerted attack by a modern military force. Supply lines would also be very long throughout the area and, in the scenario that extends beyond the Dnieper River, rely on bridging operations across a major river.

A third scenario would involve Russia taking all of eastern Ukraine up to the Dnieper and using the river as a defensive front line. When it comes to defending the captured territory, this scenario makes the most sense. The Dnieper is very wide in most places, with few crossings and few sites suitable for tactical bridging operations, meaning defending forces can focus on certain chokepoints. This is the most sensible option for Russia if it wants to take military action and prepare a defensive position anchored on solid terrain.

However, this operation would be a massive military undertaking. The force required to seize this area — approximately 222,740 square kilometers — and defeat the opposition there would need to number 91,000-135,000 troops and advance as much as 402 kilometers. Since the river could bolster defensive capabilities, the defensive force could remain roughly the same size as the attacking force.

However, with a population of 13 million in the area, the additional troops that might be required for the counterinsurgency force could range from 28,000-260,000. Russia has approximately 280,000 ground troops, meaning that the initial drive would tie down a substantial part of the Russian military and that an intense insurgency could threaten Russia's ability to occupy the area even if it deployed all of its ground forces within Ukraine.

One positive aspect would be that this operation would take only 11-14 days to execute, even though it involves seizing a large area, because Russia could advance along multiple routes. On the other hand, the operation would require such a vast mobilization effort and retasking of Russian security forces that Moscow's intent would be detectable and would alarm Europe and the United States early on.

Two remaining options that we examined were variations on previous themes in an effort to see if Russia could launch more limited operations, using fewer resources, to address similar security imperatives. For example, we considered Russia taking only the southern half of eastern Ukraine in an effort to use decidedly less combat power, but this left the Russians with an exposed flank and removed the security of the Dnieper. Similarly, a small expansion of current separatist lines to the north to incorporate the remainder of the Donetsk and Luhansk regions to make the territory more self-sustaining was considered. Both operations are quite executable but gain little in the grand scheme.

The final scenario we considered was the most limited. It involved Russia conducting small temporary incursions along the entirety of its border with Ukraine in an effort to threaten various key objectives in the region and thus spread Ukraine's combat power as thin as possible. This would be efficient and effective for the Russian military in terms of the effort required. It could accomplish some small political and security objectives, such as drawing Ukrainian forces away from the current line of contact, generally distracting Kiev, or increasing the sense of emergency there, making the Ukrainians believe Russia would launch a full invasion if Kiev did not comply.

For all of the scenarios considered, the findings were consistent: All are technically possible for the Russian military, but all have serious drawbacks. Not one of these options can meet security or political objectives through limited or reasonable means. This conclusion does not preclude these scenarios for Russian decision makers, but it does illuminate the broader cost-benefit analysis leaders undertake when weighing future actions. No theoretical modeling can accurately predict the outcome of a war, but it can give leaders an idea of what action to take or whether to take action at all. 

Three Catalysts for the Price of Gold

by James Rickards.

Mar 11, 2015.

Investors have long understood that gold is an excellent hedge against inflation. The analysis is straightforward. Inflation is caused, in part, by excessive money printing by central banks; something central banks can do in unlimited amounts. On the other hand, gold is scarce and costly to produce. It emerges in small quantities.

The total growth in global gold supplies is about 1.5% per year and has been slowing lately.

Compare this to the 400% growth in base money engineered by the Federal Reserve since 2008, and it’s easy to see how a lot more money chasing a small amount of gold will cause the dollar price of gold to rise over time.

But this is not the only driver of higher gold prices. There are at least three other catalysts – extreme deflation, financial panic, and negative real interest rates. A brief look at all three scenarios will give us a more robust understanding of gold’s potential price performance.

Mild deflation might cause the nominal price of gold to decline, although it may still outperform other asset classes that go down even more. But extreme deflation, say 5% per year or more over several years, is a central bank’s worst nightmare.

This kind of deflation destroys tax collections because gains to individuals come in the form of lower prices, not higher wages, and governments can’t tax low prices.

Deflation also increases the real value of debt, which makes repayment harder for individuals, companies and governments. As a result, defaults increase and those losses fall on the banking system, which then has to be bailed-out by the Fed.

This lethal combination of lower tax revenues, higher debt burdens, and failing banks is why the Fed will fight deflation with every tool at its disposal.

So far, the Fed has been trying to fend off deflation by using its inflation playbook including rate cuts, money printing, currency wars, forward guidance, and Operation Twist. All of this has failed. Deflation still has the economy in its grip. But when all else fails, central banks can cause inflation in five minutes simply by voting to fix a gold price of, say, $3,000 per ounce.

The Fed could make the price stick by buying gold at $2,950/oz. and selling it at $3,050/oz., in effect becoming a market maker with a 3.3% band around the target price.

If the Fed did this, all other prices including silver, oil, and other commodities would quickly adjust to the new price level causing 150% general inflation – problem solved! Don’t think of this just as an “increase” in the price of gold; it’s really a 60% devaluation of the dollar measured in gold.

If this sounds far-fetched, it isn’t. Something similar happened twice in the past 80 years; in 1933-1934 and 1971-1980.

The second scenario for higher gold prices is financial panic. This does not rely on any technical economic analysis; it’s a simple behavioral reaction to fear, extreme uncertainty and investor aversion to loss. When panics begin gold often declines slightly as leveraged players and weak hands dump it to raise cash to meet margin calls.

But, quickly the strong hands emerge and gold rallies until the panic subsides. It may then plateau at the new higher level, but the objective of preserving wealth when other asset classes may be in chaos has been accomplished.

The third driver of higher gold prices is an environment of negative real interest rates. This is a condition where the rate of inflation is higher than the nominal interest rate on some instrument. I use the ten-year Treasury note for this comparison.

Right now real rates are steeply positive since ten-year note yields are about 2% and inflation is slightly negative. This is a headwind for gold, but the Fed is determined to cause inflation while keeping a lid on Treasury rates with financial repression. The Fed wants negative real rates to encourage “animal spirits.” Investors know that it’s usually not smart to fight the Fed. In any case, the Fed will keep trying, which could make asset bubbles worse.

So gold does well in inflation, extreme deflation, panic, and an environment of negative real rates. Is there a scenario where gold does not do well? Yes. If the Fed brings the economy in for a soft landing, achieves trend growth of 3% or more on a sustained basis, avoids deflation, avoids inflation and engineers a positive sloping yield curve with positive real rates, then gold will have no immediate reason to rally. Is this possible?

Yes, but highly unlikely. Deflation is the immediate danger. Fighting deflation probably means overshooting on the inflationary side next. Bubbles are everywhere and could burst leading to panic at any time.

Trend growth will not resume without structural changes to the economy that are precluded by a dysfunctional political system in Washington. Even if the Fed’s rosy scenario did emerge, gold could still rally based on foreign buying, diminished floating supply of physical bullion, and the potential for a short squeeze.

In short, a balancing of all of the possible financial outcomes from here argues strongly for including gold in your portfolio at this entry point. There are many ways to own gold or have price exposure to gold including physical bullion, ETFs, derivatives, gold miners and gold royalty trusts.

I recommend you have a 10% allocation to physical gold if you don’t already. More specifically, American Gold Eagle or American Buffalo gold coins from the U.S. Mint. Storage should be with a reliable, insured, non- bank vault near your home or in a home safe. The best security is not to let anyone know you have the coins in the first place.

Global manufacturing

Made in China?

Asia’s dominance in manufacturing will endure. That will make development harder for others

Mar 14th 2015

BY MAKING things and selling them to foreigners, China has transformed itself—and the world economy with it. In 1990 it produced less than 3% of global manufacturing output by value; its share now is nearly a quarter. China produces about 80% of the world’s air-conditioners, 70% of its mobile phones and 60% of its shoes. The white heat of China’s ascent has forged supply chains that reach deep into South-East Asia. This “Factory Asia” now makes almost half the world’s godos.

China has been following in the footsteps of Asian tigers such as South Korea and Taiwan.

Many assumed that, in due course, the baton would pass to other parts of the world, enabling them in their turn to manufacture their way to prosperity. But far from being loosened by rising wages, China’s grip is tightening. Low-cost work that does leave China goes mainly to South-East Asia, only reinforcing Factory Asia’s dominance. That raises questions for emerging markets outside China’s orbit. From India to Africa and South America, the tricky task of getting rich has become harder.

Work to rule
China’s economy is not as robust as it was. The property market is plagued by excess supply. Rising debt is a burden. Earlier this month the government said that it was aiming for growth of 7% this year, which would be its lowest for more than two decades—data this week suggest even this might be a struggle. Despite this, China will continue to have three formidable advantages in manufacturing that will benefit the economy as a whole.

First, it is clinging on to low-cost manufacturing, even as it goes upmarket to exploit higher-value activities. Its share of global clothing exports has actually risen, from 42.6% in 2011 to 43.1% in 2013. It is also making more of the things that go into its goods. The World Bank has found that the share of imported components in China’s total exports has fallen from a peak of 60% in the mid-1990s to around 35% today. This is partly because China boasts clusters of efficient suppliers that others will struggle to replicate. It has excellent, and improving, infrastructure: it plans to build ten airports a year until 2020. And its firms are using automation to raise productivity, offsetting some of the effect of higher wages—the idea behind the government’s new “Made in China 2025” strategy.

China’s second strength is Factory Asia itself. As wages rise, some low-cost activity is indeed leaving the country. Much of this is passing to large low-income populations in South-East Asia.

This process has a dark side. Last year an NGO found that almost 30% of workers in Malaysia’s electronics industry were forced labour. But as Samsung, Microsoft, Toyota and other multinational firms trim production in China and turn instead to places such as Myanmar and the Philippines, they reinforce a regional supply chain with China at the centre.

The third advantage is that China is increasingly a linchpin of demand. As the spending and sophistication of Chinese consumers grows, Factory Asia is grabbing a bigger share of higher-margin marketing and customer service. At the same time, Chinese demand is strengthening Asian supply chains all the more. When it comes to the Chinese market, local contractors have the edge over distant rivals.

Deft policy could boost these advantages still further. The Association of South-East Asian Nations (ASEAN) is capable of snapping up low-end manufacturing. China’s share—by volume—of the market for American shoe imports slipped from 87% in 2009 to 79% last year.

Vietnam, Indonesia and Cambodia picked up all the extra work. But ASEAN could do far more to create a single market for more complex goods and services. Regional—or, better, global—deals would smooth the spread of manufacturing networks from China into nearby countries. The example of Thailand’s strength in vehicle production, which followed the scrapping of restrictions on foreign components, shows how the right policies can weld South-East Asian countries into China’s manufacturing machine.

Unfortunately, other parts of the emerging world have less cause to rejoice. They lack a large economy that can act as the nucleus of a regional grouping. The North American Free-Trade Agreement has brought Mexican firms into supply chains that criss-cross North America, but not Central and South American ones. High trade barriers mean western Europe will not help north Africa in the way that it has helped central and eastern Europe.

And even when places like India or sub-Saharan Africa prise production from Factory Asia’s grasp, another problem remains. Manufacturing may no longer offer the employment or income gains that it once did. In the past export-led manufacturing offered a way for large numbers of unskilled workers to move from field to factory, transforming their productivity at a stroke. Now technological advances have led to fewer workers on factory floors. China and its neighbours may have been the last countries to be able to climb up the ladder of development simply by recruiting lots of unskilled people to make things cheaply.

Exports still remain the surest path to success for emerging markets. Competing in global markets is the best way to boost productivity. But governments outside the gates of Factory Asia will have to rely on several engines of development—not just manufacturing, but agriculture and services, too. India’s IT-services sector shows what can be achieved, but it is high-skilled and barely taps into the country’s ocean of labour.

Put policy to work
Such a model of development demands more of policymakers than competing on manufacturing labour costs ever did. A more liberal global regime for trade in services should be a priority for South America and Africa. Infrastructure spending has to focus on fibre-optic cables as well as ports and roads. Education is essential, because countries trying to break into global markets will need skilled workforces.

These are tall orders for developing countries. But just waiting for higher Chinese wages to push jobs their way is a recipe for failure.

Q1 GDP Expectations Are Crashing

by Tyler Durden

03/12/2015 14:19 -0400

Despite the continuing commentary that all is well in America, economic growth expectations for Q1 just collapsed to a new cycle low. From just 4 months ago, growth expectations have been cut 20% to 2.4%... but that is still four times The Atlanta Fed's dismal 0.6% forecast...

The Atlanta Fed forecasts Q1 growth of just 0.6%...

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2015 was 0.6 percent on March 12, down from 1.2 percent on March 6. The nowcast for first-quarter real consumption growth fell from 2.9 percent to 2.2 percent following this morning's retail sales release from the U.S. Census Bureau.

*  *  *

It appears - just as we detailed here - that non-residential capex is catching down and the spending collapse in the hundreds of billions is looming.

*  *  *

Not "Off The Lows"

One wonders just how The Fed will wriggle out of this box...
Charts: Bloomberg