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THE TRANSPARENCY TRAP / JOHN MAULDIN´S WEEKLY NEWSLETTER ( A MUST READ )

2012-01-29T04:18:00.002-05:00

The Transparency Trap

By John Mauldin

January 28, 2012

This week we take a brief pause in our series on the choices facing the developed world to look at some items that are catching my attention. We will get back to the US next week, as somehow I think we will not solve our problems between now and next Friday, and there will be plenty left for us to talk about. So today we look at the “shift” in Fed policy, and at the balance sheets of central banks, US GDP, Portugal and the ECB, the LTRO policy, and yes, there’s even a tidbit on Greece. Plenty of ground to cover, so with no “but first,” let’s get started.

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The Transparency Trap

The Fed announced this week that it will keep rates low until 2014. Interest rates responded by getting even flatter. This policy change has caused a lot of negative press, for some good reasons, but I want to offer a somewhat different take on their motives.

Telling us that rates will stay low for another three years has a lot of negative implications. First, it says that the Fed does not expect a recovery of any significance during that time (more on this week’s GDP numbers further on). Second, it tells any individual or business that there is no reason to hurry and borrow money to get lower rates. You can wait and see how things turn out before you decide to act.

Comstock Partners minced no words in their scathing criticism:

“In our view the Fed's new policy is an act of desperation rather than something to celebrate. The FOMC has used all of its conventional weapons and a lot of unconventional ones and is essentially out of ammunition. The banking system is swimming in excess reserves that it is not using----adding more won't make much of a difference. This is a classic liquidity trap where further easing will not be much help. The stock market strength assumes that the economy is getting stronger and that company earnings will remain at elevated levels. We think that this will not be the case, and that the market is subject to substantial downside risk.”

I agree with their sentiments and conclusions, but I think the Fed is in more than a liquidity trap. For lack of a better term, let’s coin one and call it a “transparency trap.” The Fed and the FOMC do not create their policies in a vacuum. The individual members talk to business leaders at length every week, and their staffs are also seeking out opinions and reactions. While they may not talk to you and me, they are aware of the reactions to their positions. Let’s take that as a given. These are not men and women who are easily pushed into a position. They get where they are by being able to forcefully take a position and push for their policies. We may not like their positions, but they put some thought and a lot of work into making them. Frankly, it is a damn hard job. No matter what they do, they will make a lot of people upset. And this week is a case in point.

Ben Bernanke has been quite open in that he wanted a more transparent Fed. He wanted explicit inflation targets long before he joined the Fed. He wanted more communication and openness from the FOMC. Many in the media and elsewhere lauded those sentiments, including me, as the more we know about their thought process, the better we can all plan.

However, there were others who said that the Fed needed to keep theirs cards closer to their chests. Showing too much of their inner reasoning could mislead as well, as policies could change and the Fed should not feel locked into any one position if the underlying circumstances shifted. There should be an element of mystery, they maintained. Some former members of the Fed were very outspoken in their desire to not increase the transparency of the Fed. As with sausages and laws, we simply do not want to know too much about what goes into making Fed policy, they asserted.

But slowly, Bernanke has put his stamp on the Fed, including his views on transparency. His speeches and presentations are far more comprehensible than the foggy pronouncements of Greenspan. He has started doing press conferences. And with this meeting, he has persuaded the 17 members of the FOMC to offer projections about the economy – in this case, where they think rates will be for five years into the future.

The headlines talked about the Fed keeping rates flat into 2014, but if you look at their median forecast, they expect rates to rise by all of 0.5% at some point in 2014. And for the record, here are the rest of their more significant forecasts:

“The Fed knocked down its forecast of economic growth a few notches for the entire forecast period (see table below). The Fed sees the economy growing around 2.2%-2.7% in 2012. The Blue Chip consensus forecast of growth in the US is 2.2% on an annual average basis as of January 2012, while the IMF projects growth of 1.5% for the United States in 2012 on a fourth quarter to fourth quarter basis.“

The central tendency of the unemployment rate for 2012-2014 was lowered but the longer run projection was left intact. The unemployment rate is expected to be around 8.2% to 8.5% by the end of the year, which is different from the Blue Chip consensus of 8.5% (determined by a survey taken prior to the publication of the December employment report, most likely to be revised down). Inflation is projected to below the Fed’s target of 2.0% until 2014. With regard to inflation, Bernanke formally indicated that 2.0% inflation is the Fed’s target rate and this rate as being consistent with the Fed’s dual mandate.” (Asha Bangalore, Northern Trust)

All in all, not a very upbeat group. Given their views, it is no wonder they expect rates to stay low. And thus we have the transparency trap. They are now telling us what they really think, something that most people in most places wanted only a short while ago. And we see the 17 individual forecasts, so we can get a sense of the range of opinion, which is quite wide, actually. Look at the following graph, which shows us when the members of the FOMC expect rates to finally begin to inch up.

Note that six members expect rates to rise within the next two years and four expect rates to be flat into 2015, with two members thinking rates will not rise until 2016. And over whatever they define as the “longer term,” they expect the Fed Funds rate to be 4.25%. (Which causes me to mangle that song from the children’s movie classic, Snow White: “Some Day My Price Will Come.”)

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(You can see all the projections in glorious detail here )

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Tell Us What You Think We Want to Hear

If we want to know what they think, and they tell us, are we then going to shoot the messenger? We asked, they delivered. If they gave us those projections and did not change their interest-rate projections from the last meetings, they would be subject to ridicule, because they did not say in the statement what they really believed.

In a very real way, they were forced to say they expected rates to be flat for 2-3 years. To say anything else would have been rather pointless, at best, and subject to even more intense criticism at worst. Once they opted for transparency, they were forced to take the position they did. Put this in the category of “be careful what you ask for, because you may get it.”

Now, take note. And I do not mean this as a specific indictment of Fed economists and forecasters. This goes for all of us who dare venture a thought about the future.

There is a natural tendency to take current conditions and project them forward. Which is why stock analysts who forecast earnings are so predictably bad. And the all-star team of blue chip economists (in the US) have yet to predict a recession, even when one has started, let alone in advance! Once you rely on models, you are doomed to error. I have read studies that show analysts are not even as accurate as one would expect from simple random selection.

I think we should take these Fed projections as more of a curiosity, for at least the next two years. In two years we will have 16 data points (8 meetings a year) which will show us some of the evolution of their thinking, and that will be very interesting.

For what it’s worth, if someone had asked me, I would have said that rates will be flat for a very long time. We inhabit a deflationary, deleveraging reality. That suggests lower inflation. I have written at length why unemployment will be higher than we are comfortable with; it is just a product of the current environment and simple math. To see unemployment come down we need to see growth in the 3.5% range, and our next topic will show us why we are not even close to that number.

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A Very Soft GDP Number

GDP came in at 2.8% for the 4th quarter of 2011. That is a respectable headline number, given that the US economy only did 1.6% for the whole of last year. For those who look at this number as half full, I offer the following observations. First, examine GDP growth for the last few years. The 4th quarter has been much better than previous quarters, and then GDP dropped off again.
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The 2.8% number is softer than it looks. Two-thirds of that growth (1.9%) was from inventory build-up (standard accounting practice says that growth in inventory increases GDP, while sales of inventory reduces it). “Real final sales (GDP less inventory changes) expanded at an anemic 0.8% annual pace in the fourth quarter, a sharp slowdown from the third quarter’s healthy 3.2% rate. That paints a different picture from the apparent pick-up in headline GDP growth from the third-quarter’s 1.8% yearly rate. The difference reflects the shift to inventory building in the fourth quarter from a drawdown in the third quarter.” (Barron’s)

I suppose one could spin inventory growth as businesses being optimistic about future sales and building inventory, but given the weaker retail sales of late (in comparison to previous years) that is rather doubtful. And so all that really happened was a total reversal of inventory sales in the previous quarters. There will be a drawdown of inventories over the next few quarters, which will be a drag on future GDP numbers, much like the pattern we have seen the past few years.

Retail sales growth was not strong. And for the last year, 90%-plus of total retail sales has come from decreased savings, as the savings rate dropped from 4% to 2%. It will be hard to go much lower, so the “boost” we got last year from retail sales accounts for most of the year-over-year growth in GDP. If most of retails sales growth came from reduced savings, that suggests that retail sales will not offer much in the way of growth for the coming year. Just saying.

Further, when calculating real GDP, one subtracts inflation. The Fed prefers an inflation measure called PCE (Personal Consumption Expenditures). It is essentially a measure of goods and services targeted toward individuals and consumed by individuals. The number you read in the various media is the CPI or Consumer Price Index. The CPI is inflexible, in that it’s always the same basket of goods. PCE on the other hand, is supposed to take into consideration the notion that if steak is too costly, we’ll eat hamburger. The CPI is typically 0.3-0.5% higher than the PCE, which is convenient if you want the GDP number to look better.

The Fed changed to PCE in February of 2000. The change was buried in the footnotes of the annual Humphrey-Hawkins testimony by then-Fed Chairman Greenspan. So the anemic growth of 1.9% for the last decade would have been even worse if we had used the previous measurement of inflation (CPI). Understand, there is an argument in favor of using PCE, as many academics argue that CPI actually overstates inflation. But there is also an argument to use CPI. It somewhat depends on what you want the final numbers to be.

Fast forward to today, and the year-over-year change of CPI was 2.5%, with the PCE only rising 1.7%. And last quarter was down sharply, to +0.04% on an annual basis. An anomaly of lower energy and commodity costs? Partially, for sure. So if their target rate of inflation is 2%, using PCE gives the Fed grounds for a looser monetary policy.

All in all, GDP was helped by numbers that are not likely to repeat. For a long time I have maintained that the US economy is in a Muddle Through range of around 2%. I remember when last year at this time we had estimates of 4-5% growth for 2011. I looked so bearish. Now, not so much, as 2% would have been better than what we got.

I think we will be lucky to Muddle Through again this year. Mind you, if it was not for a potential shock coming from a serious European crisis and real recession, the US should not slip into outright recession this year.

Central Banks: A High-Wire Balancing Act

I got this note from bond maven (and Maine fishing buddy) Jim Bianco (courtesy of Barry Ritholtz). It made me sit up and take notice. He compared the balance sheets of the four largest central banks (the US, Europe, Japan, and China) and then four European central banks (Germany, England, France, and Switzerland). There has literally been an explosion in all their balance sheets. Interestingly, China has seen the largest growth. And where is the inflation that one would expect from all the monetary printing? You can see some of it in China, but not anywhere else.
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Jim points out that central bank balance sheets, when taken together, have spiked recently in relationship to total world stock market capitalization. He concludes with these thoughts:

What Does It All Mean?

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“2011 was so difficult because all stocks seemingly moved together. It was as if every S&P 500 company had the same chairman of the board that knew only one strategy, resulting in a high degree of correlation between seemingly unrelated companies.

“Massive central bank involvement in the markets risks returning us to a de facto centrally planned economy. Those S&P 500 companies all have the same chairman; it is Ben Bernanke because his policies are affecting everybody. That is what makes money management so difficult. Correlations will ebb and flow; they always do. But what makes them go away? This will only happen when governments and central banks go away.

“But if they go away, then does that not mean things get ugly? Maybe they do get ugly, but it also means that we sort out the excesses in the market. We reward the people that do the right thing and we punish the people that do the wrong thing. And we have an adjustment process that may be ugly, but then we have a period of long expansion.

“Central banks are ruling markets to a degree this generation has not seen. Collectively they are printing money to a degree never seen in human history.

“So how does this process get reversed? How do central banks pull back trillions of dollars of money printing without throwing markets into a tailspin? Frankly, no one knows, least of all central banks as they continue to make new money printing records.

“Until a worldwide exit strategy can be articulated and understood, risk markets will rise and fall based on the perceptions and realities of central bank balance sheets. As long as this is perceived to be a good thing, like perpetually rising home prices were perceived to be a good thing, risk markets will rise.

“When/If these central banks go too far, as was eventually the case with home prices, expanding balance sheets will no longer be looked upon in a positive light. Instead they will be viewed in the same light as CDOs backed by sub-prime mortgages were when home prices were falling. The heads of these central banks will no longer be put on a pedestal but looked upon as eight Alan Greenspan’s that caused a financial crisis.

“The tipping point between balance sheet expansion being bullish for risk assets versus bearish is impossible to know. Given the growth rate of central bank balance sheets around the world over the past few years, we might not have to wait too long to find out. Enjoy it while it is still bullish.”

You can read the whole piece at The Big Picture.

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A Few Thoughts on LTRO

The ECB is taking almost any quality asset a European bank offers up and putting it on its balance sheet, as part of its long-term refinancing operation (LTRO). Basically, this allows a bank to post an asset at the central bank and receive 1% money, which they can turn around and use to either improve their own balance sheet and liquidity or buy European sovereign debt at, say, 6%. If the bank then makes 5% on the loan and leverages it up, it can “get whole” in a short time.

This is the same principle (in theory) that Paul Volcker used in 1980 when he allowed US banks to carry the debt of defaulting Latin American countries at face value. Given enough time and interest-rate spread, a bank can work its way out of a problem. And it worked for Volcker. Eventually, US banks made enough money to be able to write off the bad debts.

While this is a band-aid, an attempt to cover up the real problem of banks that are basically bankrupt and sovereign countries that are either in default or at risk of default, it is so far proving to help. Germany has essentially thrown in the towel on keeping the ECB from printing money. While they still growl and bark, like any well-trained dog they stay in the yard. They are a big dog, and their barking makes you nervous as you walk past, but so far they are allowing the ECB to prop up banks throughout Europe. On that point at least, Sarkozy won.

As long as LTRO continues, it should postpone the problem of a true banking crisis – until Portugal has to default, and then all eyes turn to Italy and Spain. If the ECB is allowed to fund Italy and Spain, even through the back door, it will mean Germany has made its choice to keep the euro intact, no matter the cost.

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Greek Exhaustion Syndrome

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One of my very good friends had a small private dinner this week with the chairman of a major German bank, who remarked, with a sense of gallows humor, that he thought he could get his fellow German banks to chip in enough money to give to Greece to just make them go away. They really have Greek Exhaustion Syndrome.

He also thought Portugal would eventually would have to leave, and said he thought he would take a haircut on Irish debt. Italy and Spain will somehow make it. At least that is the view from the top of the German bank pyramid.

Portuguese interest rates are soaring. Without life support from Europe, they cannot keep up their borrowing at rates that will allow them to recover. While they are gamely trying to reduce their deficit, austerity is reducing their GDP and thus their tax revenues. They will have no choice but to default at some point.

The interesting case is Italy. They have room in their budget to cut, as I have outlined in prior letters. If the ECB subsidizes their debt (lowering the interest-rate cost) or an agreement is reached to lower the rate on their bonds, they theoretically could make it. But either path is default by another name. Maintaining the status quo is not possible. It will not be long before they are at 130% debt-to-GDP, if Europe falls into recession. The IMF has long maintained that 120% is the line in the sand.

It is just a matter of who pays and how the payment is made. But someone will pay.

And there’s this note for those who think austerity comes with few consequences. From the Centre for European Reform:

“Eurozone policy-makers – from President Sarkozy and Wolfgang Schäuble to the former President of the ECB, Jean-Claude Trichet – advocate that Italy and Spain should emulate the Baltic states and Ireland. These four countries, they argue, demonstrate that fiscal austerity, structural reforms and wage cuts can restore economies to growth and debt sustainability. Latvia, Estonia, Lithuania and Ireland prove that so-called “expansionary fiscal consolidation” works and that economies can regain external trade competitiveness (and close their trade deficits) without the help of currency devaluation. Such claims are highly misleading. Were Italy and Spain to take their advice, the implications for the European economy and the future of the euro would be devastating.

“What have the three Baltic economies and Ireland done to draw such acclaim? All four have experienced economic depressions. From peak to trough, the loss of output ranged from 13 per cent in Ireland to 20 per cent in Estonia, 24 per cent in Latvia and 17 per cent in Lithuania. Since the trough of the recession, the Estonian and Latvian economies have recovered about half of the lost output and the Lithuanian about one third. For its part, the Irish economy has barely recovered at all and now faces the prospect of renewed recession.

“Domestic demand in each of these four economies has fallen even further than GDP. In 2011 domestic demand in Lithuania was 20 per cent lower than in 2007. In Estonia the shortfall was 23 per cent, and in Latvia a scarcely believable 28 per cent. Over the same period, Irish domestic demand slumped by a quarter (and is still falling). In each case, the decline in GDP has been much shallower than the fall in domestic demand because of large shift in the balance of trade. The improvement in external balances does not reflect export miracles, but a steep fall in imports in the face of the collapse in domestic demand.”

Portugal and Greece are on that path, if they do not opt out of the eurozone. Italy and Spain cannot avoid the sad results of too much debt without major European support, which means the ECB, as no country will offer that amount of help, as none has the money to do so. But that means a lower-valued currency and purchasing power, higher energy and commodity costs, etc. As I keep saying, it is not a matter of pain or no pain, it is simply a choice of which pain and how much of it you want to have.

It is interesting to watch the game being played with Greek debt (merely interesting, because I have no Greek debt). Private bond holders are now looking at only getting about 30% on the euro. They are now asking that the ECB share some of their pain, and the IMF seemingly agrees that the ECB should. The ECB is aggressively resisting any such notion. An interesting principle is being set here. If you do it for Greece, then the line will get much longer. The euro is on its way to parity with the dollar, as I have said for a very long time.

Those predicting the death of the dollar (at least against major world currencies) and hyperinflation do not understand the rather vicious nature of deflation and debt deleveraging. But that is a topic for a later letter.

Ah, but what do we have here, at 3:36 AM (via my London partner, Niels Jensen), but an article by Nick Doms on Examiner.com, asserting that, yes indeed, Greece will default:

“Greece plans an orderly exit out of the Eurozone according to two sources close to Mr. Papademos, Greek Prime Minister, who spoke on condition of anonymity earlier today.   The sources confirmed that plans are ready to return to a legacy currency given the current circumstances and that such exit would be dealt with, quote ‘in as orderly a fashion as possible’ unquote….“

A Greek exit strategy will probably not be announced officially until early March when the EU finance ministers meet.”Well then, we shall see.

In the meantime, it is time to hit the send button. Once again it is late, but I will sleep in tomorrow.

Have a great week. Your am I having fun or what analyst,

John Mauldin
John@FrontlineThoughts.com

Copyright 2012 John Mauldin. All Rights Reserved

JUST DON´T LOSE IT ! / BARRON´S COVER ( A MUST READ )

2012-01-29T04:17:00.007-05:00

Barron's Cover

SATURDAY, JANUARY 28, 2012

Just Don't Lose It!

By KOPIN TAN

More than ever, investors want advisors and money managers to preserve their capital. So how can you make your wealth grow?

When stocks recently hit a six-month high, U.S. Trust's chief investment officer, Christopher Hyzy, expected to hear from investors eager to buy more shares. Instead, calls came in from clients who wanted to know if they should take profits, or how they could protect their winnings following the Standard & Poor's 500's quick 20% jump to break through 1300.

It's not just U.S. Trust investors who are cautious. Across the country, employers are gradually adding jobs, and fears of a double-dip U.S. recession have receded momentarily—enough to propel U.S. stocks up 4.7% in January, double their gain from a year ago. Yet financial advisors and money managers are listening to the same anxious refrain from their clients: Make sure you don't lose our money! Investors may be resigned to diminished returns, what with bond yields plumbing historic depths and banks paying almost no interest, but their biggest priority remains to avoid, at all cost, a repeat of the 2008's disastrous losses.

Can you blame them? The markets are in the throes of Europe's solvency crisis, and gripped by policy paralysis following the bursting of Earth's debt bubble. The messy demise of MF Global—with billions of client money still missing—coming so soon after the Bernie Madoff scandal further reinforces the suspicion that our fragile financial system is a house of cards.

And after rallying 25% in 2009 and 12% 2010, it felt ominous when the three-year-old bull market ended 2011 back where it started, but with gut-wrenchingly feral swings along the way.

This blow to sentiment could affect everything—from who runs our government, to the next generation's view of risk, to the length and strength of stock-market rallies. And it raises tough investment questions. Can you preserve your capital at today's low interest rates and still preserve your standard of living, when prices for many essentials—gas, meat, prescriptions, Prada loafers—are climbing much faster than the official 2.2% core inflation rate? Is this new cautiousness obscuring the stock market's long-term value? Are there investments that will help your returns without too much risk?

EVEN THE CURRENT RALLY has been met with unease and skepticism. Over the first four months of 2011, long-term investors had begun steering more money into stock-mutual funds than bond funds. Then the euro crisis escalated, and the U.S.'s triple-A credit rating was taken down a peg.

Since then, investors have changed course, yanking more than $163 billion from stock funds and plowing $92 billion into bonds. Overall, 2011 saw the biggest flight from stock funds since 2008 and suffered the second-worst annual exodus of the past 27 years. That funk lingers: Trading volume was down 25% across equities, credit, commodity and government-bond futures as 2012 began.

Consider other ways in which investor psyche is dented:

• A recent survey conducted by Investment News found just 43.6% of financial advisors planned to increase their clients' allocation to stocks this year, down from 63.4% at the start of 2011, when the government's quantitative-easing campaign was lifting spirits and stocks.

• A survey by the Yale School of Management showed a marked decline among investors who felt confident there wouldn't be a stock-market crash over the next six months. The outlook was especially grim among individual investors, who seemed as worried about a crash as at the height of the financial crisis. "Things in the U.S. aren't nearly as bad now as they were back in 2008 and early 2009, but don't try and tell the retail investor that," says Justin Walters, co-founder of Bespoke Investment Group. "They're truly spooked."

• Notwithstanding the downgrade of U.S. debt, investors bent on capital preservation are buying enough Treasuries to drive the benchmark yield on 10-year notes to below 2%. In Europe's strongest economy, Germany, the 30-year bund last week paid its lowest yield since the euro's inception. Things won't change anytime soon, and the Federal Reserve last week promised to keep rates near zero for three more years.

• Of more than 300 new exchange-traded funds launched in 2011, the two most popular by far were conservative strategies that steered investors toward stability and capital preservation. The iShares High Dividend Equity Fund (ticker: HDV) ended 2011 with a whopping $920 million in assets, notes Neil Leeson, Ned Davis Research's ETF strategist, while the PowerShares S&P 500 Low Volatility Portfolio (SPLV) racked up $866 million since its May launch.

• President Obama ended his third year in office with a 43% approval rating, the lowest of any president since Jimmy Carter—a sign Americans aren't too confident the administration can rouse our listless economy.

• Risk aversion is particularly acute among "Generation Y" investors born after 1980, who have decades to go before they retire but are especially reluctant to invest. These young adults "reached investing age during the dot-com bust, lived through the 2008 great recession and continue to experience significant economic uncertainty and market volatility," says William Finnegan, senior managing director at MFS Investment Management. In a survey the firm conducted last fall, 40% of Gen Y investors agreed with the statement "I will never feel comfortable investing in the stock market." Nearly a third said their primary investment objective was to protect their principal. As a result, this cohort allocates roughly 30% of their money on average to cash, more than any other age group.

BECAUSE OF THE STILL-SUBSTANTIAL macro risks—Europe's systemic debt crisis, a potential hard landing in China, and fiscal tightening in the U.S.—many strategists say the short-term outlook for stocks remains murky. As a result, the equity-risk premium—the amount investors demand to own stocks compared to traditionally risk-free assets like Treasuries—has recently climbed to its highest level in decades.

"Does it make sense that equity-risk premia are higher today than at any other time in the last 60 years?" asks Thomas Lee, JPMorgan's U.S. equity strategist. At the very least, this suggests stocks are undervalued, Lee says. History shows that at times like these, stocks can produce above-average returns even when economic growth is subpar, since the "cheaper valuation gives stocks a larger margin for error," Lee notes.
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.But persuading Americans to buy will be a challenge. At the heart of the problem is the chilling specter of countries possibly going bust, which became more likely after governments bailed out the private sector and took on much of their debt. Until 2011, there was a well-entrenched notion of a risk-free rate, which was "built on the sanctity of developed countries' sovereign-debt markets," says Nicholas Colas, chief market strategist at ConvergEx Group. But that bedrock principle has since been reduced to rubble after our debt-ceiling debate introduced the possibility that the U.S. might miss a coupon payment, and credit agencies took to slashing sovereign ratings. In Europe, a monetary union without fiscal unity is proving to be a disaster, while in China, investors fear that aggressive lending has merely swapped a prolonged recession for a looming property bubble.

Not surprisingly, an index measuring economic-policy uncertainty tracked by professors at Stanford and the University of Chicago recently jumped to an all-time high. Things may not improve anytime soon. Citigroup's London-based economist Michael Saunders expects a credit downgrading of the U.S., Japan, France, Italy, Spain, Austria, Belgium, Finland, Ireland, the Netherlands and Portugal over the next two to three years.

THIS LONG, MESSY REHABILITATION of the debt-scarred global financial system has overshadowed U.S. companies' stalwart earnings, record cash holdings and reasonable valuation, with large-cap U.S. stocks trading at just 13 times projected profits, well below their median of 15.7 times over the past decade.

Such competing—and compelling—buying and selling impulses have trapped the market in a violent tug of war that has frightened investors. Last year saw 68 sessions where the Standard & Poor's 500 jumped or fell more than 2% within one session. In contrast, there were just two such days in all of 2005. Last year also produced a record 70 days when nearly every single stock seemed to rise or fall at once—so-called "all or nothing" days when advancers or decliners within the S&P 500 outnumbered the other camp by more than 400. In contrast, there were just 67 such days over the 15 years from 1990 to 2004. This wreaked havoc with the long-cherished principle that investors can minimize risk with diversification and by holding a variety of stocks.

It didn't inspire investor confidence that professional traders also struggled mightily. Roughly 48% of money managers trailed their respective benchmarks by 2.5 percentage points or more in 2011—the worst annual record since 1998, according to JPMorgan. The results were particularly dismal among large-cap growth funds, where an astounding 70% trailed their benchmarks by 2.5 percentage points or more.

Coming so soon after a lost decade of returns, investors can be forgiven for fretting about their investments. Hobbled by the bursting of the tech and debt bubbles, the S&P 500 ended the 2000s with a total return of -0.96%, the worst decade since the 1930s' 0.33% haul, and a cruel decline from 17.4% during the 1980s and 18.1% over the 1990s.

STOCKS' RECENT SHOWING would have been worse if it weren't for boring dividend-paying companies, which provided all of last year's 2.1% return and made a positive contribution in the 2000s. That's quite a shock for boomers. In the 1990s, for example, dividends' 2.8% return was overshadowed by rallying stock prices, which added 15.3%.

No surprise, then, that investors are flocking to cash-rich, yield-paying companies, which many believe might be more stable and less risky in a volatile market. Cincinnati-based Bahl & Gaynor, which has focused on higher-quality dividend-paying stocks since 1990 and has trademarked the phrase "Dividends pay dividends," last year saw assets under management leap to a record $5.1 billion—from $3.2 billion in 2010.

"Baby boomers burnt by recent crashes are anxious not to relive 2008," says Matthew McCormick, a Bahl & Gaynor portfolio manager. But the traditional ways for investors to preserve their capital—by clinging to cash or buying government bonds—are now rendered quixotic by interest rates near zero and Treasury yields plumbing fresh hells.

Detractors argue that the zeal for dividends has become a crowded trade, but McCormick disagrees. Demand for stable dividend payers is supported by demographic trends, what with the horde of baby boomers nearing retirement age and looking for income that can keep pace with inflation.

"Healthier corporate balance sheets, with more cash on companies' books, also mean companies are better positioned to pay or increase dividends," he says. "Besides, padding dividends is about the only way for corporate insiders to give themselves a raise without catching political flak."

Bahl & Gaynor screens for companies that pay a yield of at least 2%, and that have raised their dividends in at least two of the past five years. The firm then scours companies' fundamentals to get a portfolio with an average market cap of $56.1 billion, an average yield of 3.7% and 8% average dividend growth over the past five years. Its top holdings include McDonald's (MCD), Philip Morris (PM), Abbott Laboratories (ABT), Intel (INTC), Bank of Nova Scotia (BNS), Oneok (OKE) and Bristol-Myers Squibb (BMY).

While safer dividend-payers have lagged behind riskier assets in January's rally, Jack Ablin, chief investment officer at Harris Private bank, thinks they will remain crucial. More than 7,000 Americans hit their 65th birthdays each day, and their ranks will swell from 13% of the population now to about 18% by 2030.

Dividends have accounted for nearly half the S&P 500's annualized total returns over the past 84 years, and Ablin expects "the income component will continue to play a vital role in equity returns over the long term."

HYZY OF U.S. TRUST, which is Bank of America's private-wealth unit, also believes in "being paid to wait while the market repairs itself." The credit crisis has brought a new paradigm, where the world is trying to repair the bloated debt structure of recent decades. This process takes time, and the investment environment will remain fragile. Until policy makers manage to produce lasting results, instead of merely kicking the proverbial can down the road, "we believe we're facing another year of bouts of sharp volatility, dictated once again by a policy-heavy climate."

Among other things, Hyzy thinks the S&P 500 could finish 2012 between 1325 and 1350, within a hair of last week's levels, and recommends paring risk when the index approaches the upper end of its range. (U.S. Trust, for example, trimmed its suggested allocation to stocks from overweight to neutral this month when that occurred.) Hyzy also suggests putting some money toward diversified, multi-strategy hedge funds, since they have more tools for betting against the market, beside just going to cash. In the face of persistently low rates, he also suggests deploying a "crossover strategy" with bonds that includes allocating money to corporate debt (both investment-grade and high-yield), other fixed-income assets (including municipal, mortgages and agencies), and diversifying beyond U.S. and European sovereign bonds to include countries—like, say, Canada and Norway—that have strong currencies and steeper yield curves.

With yields depressed as long as global growth is slow, Rebecca Patterson, JPMorgan Asset Management's chief market strategist, also suggests looking to higher-yielding assets like emerging-market and corporate debt as well as equities. There are also "alternative assets" like mezzanine debt, which may be less liquid but pay a longer-term return of about 7.5% and are less correlated to global risk-on, risk-off flights.

Now that 2011 has destroyed the notion of a risk-free interest rate, how long before global central banks and sovereign wealth funds realize the need to diversify away from their vast stockpiles of sovereign bonds? After all, the world has only 200 or so issuers of sovereign debt.

Less than two-thirds of these are rated by Moody's or S&P, often based on subjective criteria like political risk, and five of them alone—the U.S., U.K., Japan, France and Germany—make up 77% of the $21 trillion Barclays Global Treasury Index. Compared with this rather limited choice, corporate bonds are issued by thousands of companies that are rated on more transparent yardsticks like their balance sheets. "The events of 2011 opened the door to thinking about sovereign risk as a species of credit risk," Patterson argues, and this sets the stage for a gradual, long-term shift from sovereign to corporate bonds.

Investors, too, should start rethinking what constitutes a safe, productive portfolio.

INDIA´S YEAR OF LIVING STAGNANTLY / PROJECT SYNDICATE ( VERY HIGHLY RECOMMENDED READING )

2012-01-29T04:14:00.003-05:00

India’s Year of Living Stagnantly

Jaswant Singh

2012-01-25
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NEW DELHI – Will 2012 prove to be a year of renewal for India, or another annus horribilis? No country progresses unerringly, but India cannot afford another politically and economically torpid year like 2011. For India, last year is a year best forgotten.

India has been so deeply mired in political paralysis that the Nobel laureate economist Amartya Sen recently said that the country has “fallen from being the second best to the second worst” South Asian country, and that it is currently “no match for China” on social indicators. This is a damning comment on a country that held such promise just a short time ago.

In early January, the American social critic James Howard Kunstler described India as “a nation with one foot in the modern age and the other in a colorful hallucinatory dreamtime.”

Kunstler’s view is harsh, but perhaps prophetic: India’s “climate-change-related problems are doing heavy damage to the food supply. Their groundwater is almost gone. The troubles of the wobbling global economy will take a lot of pep out of their burgeoning tech and manufacturing sectors.”

Indeed, suddenly, India’s economy has begun spinning out of control. Last year, the country’s GDP growth slowed, manufacturing plummeted, and inflation and corruption grew uncontrollably.

Elected and unelected government officials alike, including cabinet ministers, members of parliament, and civil servants, were implicated in corruption scandals. The situation triggered recollections of Prime Minister Indira Gandhi’s fraudulent call for a state of emergency in 1975, when she ruled by decree for 21 months, suspending elections and civil liberties.

The population’s outraged response to these events was visceral, and previously unknown figures such as the anti-corruption activist Anna Hazare rallied thousands of Indians in meetings across the country to protest against government corruption. As Prime Minister Manmohan Singh’s government floundered, the opposition vainly sought to gain the upper hand.

But, to ordinary Indians, this political gamesmanship appeared to be merely a farce – the blind pretending to lead the unsighted. Perhaps for the first time ever, India’s government failed to enact even a single piece of legislation, much less undertake any economic reforms, restore price stability, or address widespread civil disorder.

As the Indian business analyst Virendra Parekh has observed: “The second fastest-growing economy in the world now has the unenviable distinction of having the fastest falling financial markets in Asia.” Moreover, “the fortunes of the rupee are tightly linked with the euro, which is in the throes of an existential crisis...” This has resulted in another, albeit unintended, consequence: “Unscrupulous politicians, bureaucrats and businessmen, who have stashed their illicit wealth abroad, are bringing some of it back,” passing off the money as export earnings. Where corruption has been absent, incompetence has replaced it.

Furthermore, weaknesses in agriculture, energy, infrastructure, and governance have all contributed to India’s current crisis. For example, approximately a quarter-million Indian farmers have allegedly committed suicide over the last 16 years, despite unprecedented economic growth.

This statistic begs the question of why India continues to import foods and oils that could be produced domestically. Solutions offered by organizations such as the US-India Business Council or USAID do not address the problem’s roots, and the crisis will most likely continue in 2012. It is imperative that India invest in its agriculture, not only for economic reasons, but also because it is central to the country’s culture.

Another concern is nuclear power. In 2008, the United States and India agreed to a civil nuclear deal that would allow India to expand its nuclear-power capability. In 2010, India’s parliament passed the Civil Liability for Nuclear Damage Bill, a precondition for activating that agreement. But, following Japan’s Fukushima nuclear disaster in March 2011, safety concerns surrounding nuclear power are large and mounting.

Local farmers, fishermen, and environmentalists have spent months protesting a planned six-reactor nuclear-power complex on the plains of Jaitapur, south of Mumbai. In April, the protests turned violent, leaving one man dead and dozens injured. India will certainly see more anti-nuclear clashes in 2012.

At the heart of India’s current malaise is a paradox: rapid growth in real income has not been matched by genuine advances in living standards. If the country’s fundamental problems are to be addressed, India needs a government with the determination, integrity, and intelligence to meet the complex demands of modern governance in the twenty-first century.

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Jaswant Singh, a former Indian finance minister, foreign minister, and defense minister, is the author of Jinnah: India – Partition – Independence.

Copyright: Project Syndicate, 2012.

CHINA´S VERY MYSTERIOUS DATA / TELEGRAPH.COM.UK ( A MUST READ )

2012-01-29T04:13:00.008-05:00

China’s very mysterious data
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By Ambrose Evans-PritchardEconomics
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Last updated: January 26th, 2012

A quick observation.

I could not help noticing that China’s imports from Japan fell 16.2pc in December. Imports from Taiwan fell 6.2pc.

The Shanghai Container Freight Index fell 1.4pc to a record low of 919.44 in November, after sliding relentlessly for several months. It has picked up slightly since.
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The Baltic Dry Index measuring freight rates for ores, grains, and bulk goods, has fallen 44pc over the last year. Kasper Moller from Maersk in Beijing said weak Chinese demand for iron ore was the key culprit.
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Cautionary warning. The BDI index also reflects the shipping glut, so it is not a pure indicator. However, rail, road, river and air freight volume for the whole of China fell to 31780m tons in November (latest data), from 32340m tons in October. Not a big fall, but still negative. (National Bureau of Statistics of China.)

Chinese electricity use was flat in over the Autumn, with a sharp fall in the (year-on-year) growth rates from 8.9pc in September, to 8pc in October, and 7.7pc in December.

Residential investment has been contracting on a monthly basis, and of course property prices are now falling in all but two of China’s 70 largest cities.

So how did China pull off an economic growth rate of 8.9pc in the fourth quarter?
Beats me.

I strongly suspect that the trade and power data reveal the true state of China’s economy.

There clearly was a pick up in early January but I stick to my view that China has inflated its credit bubble beyond the limits of safety – an increase of 100pc of GDP in five years, or twice US credit growth from 2002-2007 – and that Beijing cannot continue to gain much traction with this sort of artificial stimulus.

Indeed, the extra boost to GDP from each extra yuan of credit has collapsed, according to Fitch Ratings.

A final point. There is a widespread misunderstanding that China’s households can easily come to the rescue by cranking up spending because they have the world’s highest savings rate, and consumption is just 36pc of GDP.

Prof Michael Pettis from Beijing University puts that one to rest. The Chinese do not have a much higher personal savings rate than other East Asians. The reason why consumption is so low is that wages are low, the worker share of GDP is low, and the whole economy is massively deformed and tilted towards excess investment.

This is deeply structural. It cannot be changed with a flick of the fingers, and contains the seeds of its own destruction.

China is a marvellous country. I wish them the best. But they have not found the secret formula for perpetual uber-growth.

No such formula exists.

MONEY FOR NOTHIN´ AND BIPS FOR FREE / BARRON´S ( VERY HIGHLY RECOMMENDED READING )

2012-01-29T04:13:00.002-05:00

Up and Down Wall Street

THURSDAY, JANUARY 26, 2012

Money for Nothin' and Bips for Free
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By RANDALL W. FORSYTH
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The Fed's plan to keep rates at zero is music to the ears of gold bulls.
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I have no idea if Ben Bernanke is a fan of Dire Straits, but he will be playing "Money for Nothing," the British rock band's 1985 classic hit, through the end of 2014. That's how long the Federal Reserve figures on holding its key target interest rate, the overnight federal funds rate, close to zero, making six years at the top of the policy charts since Bennie and the Feds' version of money for nothing was released.

The "bips for free" part refers to basis points, or hundredths of a percentage point, which bond-market fans shorten to "bips." The Fed has maintained a 0-25 basis-point fed funds target ever since December 2008 at the depths of the financial crisis, at which point it ran out of bips. Since last year, the central bank had said the fed-funds rate would stay near zero through mid-2013. Tuesday, it extended the offer and the bips will be free through the end of 2014.

That was part of the new wave of transparency, which Bernanke has made a key theme during his gig at the Fed. The Federal Open Market Committee for the first time announced its expectations for the path of the fed-funds rate along with its projections for the economy, including gross domestic product growth, unemployment and inflation. (The Fed lays out the full score here.)

Just as a musical manuscript contain notes that are open to interpretation by the artist, the numbers and Bernanke's interpretation leaves a distinct impression. As long as inflation -- as defined by the Fed's favored measure of the personal consumption deflator -- remains at or below 2%, and the unemployment rate stays well above its long-term presumed natural rate somewhere between 5% and 6%, the central bank won't raise the fed-funds rate.

By the end of 2014, when the FOMC expects the jobless rate to be approaching 7%, it expects to begin hiking the fed-funds rate. The chart of the forecasts represents the full complement of the FOMC -- normally the seven members of Fed's Board of Governors and the presidents of the 12 district banks. Only the members of Fed Board actually vote, along with five district presidents, with the New York Fed president serving as a permanent member and FOMC vice chairman, while the other district presidents rotate annually. With the vacancies on the Board, there are only 17 data points and 10 voting members on the FOMC.

In his press conference, Bernanke emphasized the dual mandate given the Fed by Congress, to minimize both inflation and unemployment. And he properly rejected the so-called Phillips Curve trade-off, which asserts more jobs can be bought by tolerating higher inflation. Channeling Milton Friedman, Bernanke said inflation is a function of monetary policy while the labor market depends on an array of non-monetary variables.

That said, however, the Fed expects to maintain extraordinarily low short-term rates as long as inflation remains around its 2% target and unemployment stays well above 7%, a far sight away from the current 8.5% jobless rate.

At least that's how FOMC statement read. But BCA Research's Daily Insights (from the publishers of the influential Bank Credit Analyst) notes the committee's language was skewed in favor of the view of Bernanke and other prominent policy doves, which would include Fed Vice Chairman Janet Yellen and New York Fed President Bill Dudley. "If it were a simple majority vote, the Fed would tighten much earlier" than late 2014, according to BCA.

What emerges is a 2% inflation target, which Bernanke defended at his press conference as providing a cushion against deflation. Most Americans feel a higher inflation rate, given the cost of necessities such as food and energy, which are defined out of the "core" measures. Meanwhile, the fastest pace of price increases is felt in the least discretionary items, such as medical care and tuition. Those rising costs reduce real incomes for strapped families. The plunge in flat-panel television prices fails to provide much of an offset.

The Fed's declaration that rates will remain pinned near zero until late 2014 also opens the door for another round of quantitative easing, or outright Fed purchases of securities to expand its balance sheet. But the main beneficiary would be the financial markets rather than the real economy, contends Uwe Parpart, chief strategist and head of research of Reorient Financial Markets, a Hong Kong-based institutional brokerage firm.

While the Fed plans to continue to give money for nothing until the end of 2014, the European Central Bank also last month coincidentally provided cheap, three-year loans to banks. Parpart, in an interview with CNBC International, counts some 30 interest-rate cuts around the globe, with the latest coming from Thailand's central bank.

That's providing liquidity to get stocks going, Parpart observes; the economy is another matter. He harkens back to a similar move in Japan in 1999, which he notes didn't "kick-start the economy." Policy changes, especially regarding regulatory constraints, are what's needed in the U.S.

The markets are the ultimate arbiter of policy (even if the French socialist candidate for president recently declared himself an enemy of finance.) The biggest beneficiary of the Fed's announcement of its intention of free money through 2014 was gold and gold stocks.

While the S&P 500 SPDR exchange-traded fund (ticker: SPY) pulled out of the red after the Fed's statement at midday and ended up 0.84%, the SPDR Gold Trust (GLD) jumped 2.72%. And the Market Vectors Gold Miners ETF (GDX) surged 6.58%--even more than Apple (AAPL), which surged 6.24% on its blow-out earnings report. And both were dusted by the Market Vectors Junior Gold Mine ETF (GDXJ), which soared 7.62%, with almost the entire move coming after the Fed announcement.

"Money for nothin' and bips for free" is the tune gold bulls are humming. Whether that will inspire a wave of hiring, as Bennie and the Feds hope, is another matter.

THE FED, THE S&P500; WHY GOLD IS SHINING BRIGHT / THEGOLDANDOILGUY.COM ( VERY HIGHLY RECOMMENDED READING )

2012-01-29T04:13:00.001-05:00

The Fed, the S&P 500, & Why Gold Is Shining Bright

January 27, 2012

By Chris Vermeulen

“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”
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~ Thomas Jefferson ~

Well here we are, caught between resistance in the S&P 500 around the 1,330 area and support around the 1,300 price level. My last two articles have discussed why I was expecting a top in the coming days and weeks ahead, but prices just continued to work higher.

One of the things that I pride myself in as a person who trades and writes about financial markets in public is that I am always honest. If I blow a call I fess up and admit it. When I have made mistakes in the past, I always try to learn something new from them and I discuss losing trades publicly with readers and members of my service.

This time is different. I honestly do not know if I am going to be right or wrong. The price action in the S&P 500 Thursday was certainly bearish short term, but a back test of 1,300 or possibly even 1,280 could give rise to a Phoenix. Granted, the Phoenix is nothing more than Ben Bernanke’s pet, but that is a topic for a different time.

I have scanned through my list of indicators which discuss sentiment based on momentum, put/call ratio, the advance/decline line, Bullish Percent Indicators, and several ratio based indicators and they are all SCREAMING that a top is near. The interesting thing about the previous statement is that it would have been true a week ago and mostly true two weeks ago, yet prices have continued to climb.
The daily chart of the S&P 500 Index demonstrates the recent price action that has continued to climb the “Wall of Worry” for several weeks:

S&P 500 Daily Chart
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The culmination of the massive run higher for the S&P 500 was the dovish comments coming from Ben Bernanke during Wednesday’s press release and press conference.

The U.S. & European Central Banks are seemingly in a perpetual race to debase their underlying fiat currencies. The race will not end well. In fact, this type of situation smells like a Ponzi scheme where Ben Bernanke and Mario Draghi (ECB President) are the wizards behind the curtains. Their loose monetary policies and forced reflation are synthetic drugs that juice risk assets higher and ultimately Mr. Market will have his vengeance in due time.

At this point, it seems like Ben Bernanke will do anything to juice equity prices higher. I think his hope is that they will be able to artificially keep the game going until the recovery is on a more sound footing. However, when the entire recovery is predicated on cheap money and liquidity and is not supported by organic economic growth it just prolongs the inevitable disaster.

As an example, the daily chart of the Dow Jones Industrial Average is shown below. I would point out that Dow came within 35 points (0.27%) from testing the 2011 highs. Furthermore, the Thursday high for the Dow was only 1,356 points (10.55%) from reaching the all-time 2007 October high.

Dow Jones Industrial Average Daily Chart

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I have argued for quite some time that the economy and the stock market are two different things. If Bernanke and his cronies succeed in reflating the financial markets and the Dow reaches its October 2007 high in the near term, more retail investors will regard equity markets as being rigged.

Who could blame them for viewing financial markets as a giant rigged casino that stands to win while they continue to lose their hard earned capital? We all recognize that the current economy is nowhere near as strong as it was in 2007. But alas, the regular retail investor does not recognize that the stock market and the economy do not portray the same meaning.

One specific underlying catalyst that has gone largely unnoticed by most of the financial media during this sharp run higher in stocks is the total lack of volume associated with the march higher. The NYSE volume over the past 2 months has been putrid when compared to historical norms.

As a trader, I am forced to take risk through a variety of trade structures. However, the idea that a crash could be coming seems hard pressed as long as Big Bad Ben is at the wheel.

If the Russell 2000 drops 10%, I am convinced that Ben will be out making announcements that the Fed stands ready to intervene with all of the supposed tools they have at their disposal. Let’s be honest here, they really have one tool comprised of 3 separate functions which are all a mechanism to increase liquidity in the overall system. To express this liquidity, the following chart from the Federal Reserve shows the M2 money supply levels:

Current M2 Money Supply

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The 3 functions are the printing of currency, the monetization of U.S. Treasury debt (QE, QE2, QE2.5, Operation Twist), and exceptionally low interest rates (ZIRP) near 0 for an “extended period of time (2014).” Since monetary easing is all that the Federal Reserve has done since the financial crisis began, it begs to reason that the Federal Reserve has no other solutions or tools available. If they did, they seemingly would have used them by now.

The first bubble they created due to loose monetary policy was the massive bubble in oil in 2008. Fast forward to the present, and they are currently supporting another bubble in U.S. Treasury obligations. The bubble that they will create in the future when the game finally ends will be in precious metals. The precious metals bubble will be building while the Federal Reserve and the U.S. Treasury attempt to keep the Treasury Bond bubble from bursting.

At this point in time, if we continue down this path stocks will not protect investors adequately from inflation should the Treasury bubble burst. I would argue that the central planning and monetary policy we have seen the past few years continues in the United States and Europe that gold, silver, and other precious metals are likely to begin their own bubble of potentially epic proportions.

As the weekly chart of gold futures illustrates below, gold has recently pulled back sharply and has broken out. I will likely be looking for any pullbacks in gold as buying opportunities as long as support holds.
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Gold Weekly Chart

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In closing, for longer term investors the stock market might have some serious short term juice as cheap money and artificially low interest rates should juice returns. However, eventually equities will start to underperform. At that point, gold will be in the final stages of its bubble and the term parabolic could likely be applied.

If central banks around the world continue to print money there are only a few places to hide. Precious metals and other commodities like oil will vastly outperform stocks in the long run if the Dollar continues to slide. The real question we should be asking is who will win the race to debase, Draghi or Bernanke?

By: Chris Vermeulen – Free Weekly ETF Reports & Analysis: www.GoldAndOilGuy.com
Co-Author: JW Jones – Free Weekly Options Reports & Analysis: www.Optionnacci.com

FOOD SECURITY : DAMPENED PROSPECTS / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

2012-01-28T04:19:00.003-05:00

January 25, 2012 7:20 pm

Food security: Dampened prospects

By Louise Lucas and James Fontanella-Khan

As population growth outstrips agricultural gains, policymakers will have to juggle the conflicting need to provide food and jobs while curbing damage to the environment

Bangladeshi women farmers in rainbow-bright saris survey their flooded rice paddies with dismay: the rains have drowned the tender seedlings and, with them, their livelihoods. Climate change, ill-judged policies, protectionism, urbanisation and plain greed have all conspired to reignite Malthusian prophesies of a growing world population unable to feed itself.

Come 2050, the UN predicts earth will be home to another 2bn people; in order to feed us all, production needs to increase by an estimated 70 per cent. That is a big task, not least since the land that humans have so long been tilling is itself facing a revolution. Agriculture, which provides a livelihood to an estimated 2.5bn people, is lagging behind population growth.
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To reverse that course, many experts say another “green revolution” – the yield-boosting transformation of farming in the 1960s and 1970s by the use of better science – is required, entailing superior seeds, husbandry and technology. It could include genetically modified crops, a technique that – just like nuclear power for the world’s energy needs – to its champions forms an integral part of the solution, but to its critics represents a threat to human and environmental well-being.

The prospect of more starving people as staples become unaffordable has put the question of food security firmly on to the top table of global policymaking. Nicolas Sarkozy, the French president, made it a central plank of his country’s presidency last year of the Group of 20 leading industrialised and developing nations; Mexico, this year’s G20 chair, is taking up the baton. At the World Economic Forum in Davos this week, several sessions are devoted to the topic.

Yet these discussions will take place against a backdrop that is not just far removed from the regularly ravaged crops of Asia and elsewhere, but is also one of commodity prices that are in retreat from the peaks of recent years. Amid fears about the health of other parts of the global economy – such as banking and public finances – food security is in danger of being overshadowed.

This is anathema to those urging action. “The fact that prices have come down does not at all change the long-term picture: that in 2050 we will have 9bn-plus people to feed,” says Kostas Stamoulis of the UN’s Food and Agriculture Organisation.

“The issue is here today already,” adds Paul Polman, chief executive of Unilever, who will be discussing food security at Davos. “Every six seconds a child dies of hunger. More people are going to bed hungry now than two to three years ago, before the crisis.”

Governments, industry and civil society across the globe are scrabbling to come up with solutions. India, home to the largest number of starving people in the world, last month secured cabinet approval for a landmark bill guaranteeing heavily subsidised grain to poor families. The measure aims to underpin the health and life chances of more than 60 per cent of India’s 1.2bn population, although sceptics question whether providing grain but not other nutrients can eradicate malnutrition.

Across the developing world, industry is also pitching in. Companies such as Unilever, Nestlé and PepsiCo are helping farmers with the provision of seeds, fertilisers and even microfinance – thereby gaining what SABMiller, the emerging markets brewer, calls a “licence to trade” and helping to secure their own supply of raw materials.

Non-governmental organisations carry out similar activities. But whether private sector or charitable, all these efforts remain piecemeal. “We need to scale up faster and bigger by working together,” says Mr Polman, who chaired the Food Security Working Group set up under the business subgroup of the G20.

For one, he proposes an aid transfusion of $70bn-$80bn to compensate for years of declining investment in agriculture. As the World Bank and other lenders and donors retreated from the field, the buoyant growth in yields unleashed by the green revolution sputtered. Bill Gates, the software billionaire philanthropist, is one who says it is time to reboot that revolution.

“In the last decade we backed off,” he told BBC radio before travelling to Davos. “And now we realise that was a mistake, so we need to get back in there and fund that.”

However, to get more food from the same (or, given trends such as urbanisation, less) land requires more productive crops. But India illustrates why agricultural investment is only part of the solution. Production of food grains in the world’s second most populous country are at record highs and on track to reach 245m tonnes in the year to March, comfortably enough to meet demand of about 220m tonnes.

The same is true on a global scale. “Today, supply is not a problem,” argues Shenggen Fan, director-general of the Washington-based International Food Policy Research Institute. Rather. Or as Gary Markham, director of agriculture at accountants Grant Thornton, says: “Food is in the wrong place.” While parts of Africa starve, warehouses in China are overflowing – as are western dining tables, one-third of whose food ends up in household or restaurant bins.

Mr Fan points to the distortions created by countries’ stockpiling – “We don’t know how much China has, it could easily be 50m-300m tonnes of grain” – as an issue for governments to resolve through improved transparency and information.

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For India and much of Africa, the bigger issue is access and waste. New Delhi reckons that every year up to 40 per cent of Indian fruit and vegetables rots in the fields or on the way to market. Thousands of tonnes of grains such as wheat and rice are also rendered inedible because of a lack of rodent-free cool storage.

The cost of this wastage rings in at almost $20bn, according to government estimates. It is one reason why many welcomed recent – and still faltering – plans to open up the country’s retail sector in the hope that big supermarket groups would establish better supply chains.

Then there are the government policies and market forces that, some argue, exacerbate the supply situation. Chief of these are biofuels. While the US has withdrawn fiscal support for ethanol and biodiesel, other parts of the world continue to encourage such production – viewed by critics as taking food out of bellies to put fuel into motors.

The issue illustrates the bigger policymaking challenge of balancing the sometimes conflicting need for food and for jobs, while also reducing environmental damage. “A hungry world is a dangerous place – it causes rioting,” says Mella Frewen, director-general of FoodDrinkEurope, a trade grouping. But so is a world without adequate work.

“It’s a huge social dilemma,” says Mr Markham, pointing to EU proposals that would link support payments to employment – meaning more people on farms rather than efficient mechanised farming.
Equally, more bountiful crops do not necessarily translate into a more abundant mother nature.

Rampant fertility can also harm the soil and the livelihoods of those who till it. Vandana Shiva, an environmentalist currently advising the king of Bhutan to make the Himalayan nation wholly reliant on organic farming, claims the green revolution has ravaged the world’s ecosystem. “It has eroded farming soil, waterlogged deserts, pest-infected crops and indebted farmers,” she says.

John Beddington, chief scientific adviser to the UK government, prefers to see the two problems dovetailing into one solution: “Agriculture has the potential to mitigate climate change,” he says. That means looking at ways to increase productivity while reducing greenhouse gases, instead adopting practices that sequester carbon dioxide – such as ploughing legumes into the soil that put back essential nitrogen.

Away from the fields, blame is also meted out to self-interested governments and banks – and they too must be brought to heel, critics argue. That means ending protectionism and export bans, such as that imposed by Russia in 2010 after a drought devastated crops and wildfires spread across the country. It also means stamping out the speculation that, critics contend, sometimes goes hand-in-hand with government edicts to cause spikes in commodity prices.

Glencore, the world’s biggest commodity trader, last April admitted to a speculative bet on rising wheat and corn prices in the early stages of the previous summer’s drought – while simultaneously, senior traders publicly urged Russia to impose a grain export ban. When Moscow did just that a few days later, grain prices rallied.

Mr Sarkozy has been blunt on the subject of speculators, saying an unregulated market is “a lottery in which fortune smiles on the most cynical”. He also wants a central crop database and limits on export bans.

But while he has supporters among some governments, much of industry and most NGOs, many concede that getting powerful operators – be it Goldman Sachs’ commodities trading desk or officials in a ministry in Beijing – to be more transparent would be a tough ask.

The tensions in securing cross-disciplinary global agreement are one reason why the food and drink industry and NGOs have taken matters into their own hands, at least at a micro level, by supporting farmers from whom they buy produce. Banks and commodity traders are also slowly getting in on the act. Rabobank of the Netherlands, for example, has launched a barter programme in Brazil. Under this, fertiliser suppliers are paid with crops, which they in turn sell to traders.

But the job is bigger than they can hope to fill. “Individual governments have responsibility at the end of the day to have their people properly fed,” says the FAO’s Mr Stamoulis. “But we think experience shows a coalition of government, private sector, local communities, farmers and civil society in general [is required].”

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There are moves on the demand side too. Government health campaigns are “nudging” Britons to throw out less food. Elsewhere, campaigns advise citizens to, say, go vegetarian for a week or stick to sustainable produce.

More radically, Ifpri’s Mr Fan calls for a tax on meat to reflect the “social costs” of climate change, water and healthcare. “Take it all into consideration and beef will probably be 10 times more expensive,” he says.

That may prove tough to implement. Governments have already been attacked for introducing far milder taxes on sugar and fats.

More palatable are some of the small agricultural steps aimed at boosting supply and ensuring fewer people go to bed hungry. Take rice: thanks to funds and scientific help from overseas, some of the Bangladeshi rice farmers have been able to disprove Malthus’ gloomy prognosis. So-called “scuba rice” can survive up to two weeks of being submerged and still send its green shoots upwards when the waters clear.

Biplob Sarker, one smallholder, says he “gave up hope” after 17 days of flooding. “But, to my surprise, the seedlings grew green again after the flood. Still I can’t believe I have got 18 mauds [672kg] of paddy from there.” The challenge for the world is to multiply that surprise.

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Genetic modification: resistance even among the poor

It is the technology that dare not speak its name. Genetic modification roughly translates – in Europe and many of the poorer countries that receive its aid – as Frankenstein tomatoes: an unnatural means of playing God that may have us all sprouting extra limbs. So politicians see few votes in advocating GM, even though it can be used to engineer crops that are more disease- or drought-resistant or grow more abundantly, write Louise Lucas, James Fontanella-Khan and Alan Rappeport.

Even as Monsanto of the US on Wednesday abandoned plans to sell an insect-resistant maize in France, European scientists and government officials are starting to test the waters. UK research trials on wheat modified to repel aphids began this year, although officials insist their crop is not for human consumption.

The US, where farmers have been planting genetically engineered crops since 1996, is less squeamish. Still, big US food companies that use the produce have come under attack. Critics complain the food is unsafe and criticise Monsanto, the GM seed provider, for its aggressive treatment of farmers. But such criticism did not stop BASF of Germany from recently transferring its biotechnology unit, which researches GM crops, to Raleigh, North Carolina.

Food and drink makers, who stand to benefit from GM, are generally in favour. “Can it be right that people in the Horn of Africa have been starving because food can only be transported through Kenya, whose politicians are being put under pressure by the EU not to handle anything GM?” asks Paul Polman, chief executive of Unilever, who chaired the food security working group set up by the World Economic Forum and the Group of 20 leading nations.

But even in countries where famines occur, public resistance is firm. India, which briefly flirted with GM aubergines, backtracked in 2010 when Jairam Ramesh, then environment minister and now in charge of rural development, put a moratorium on GM crops. “There is no hurry to introduce Bt brinjal [GM aubergines] on the pretext of food security,” Mr Ramesh said at the time.

Vandana Shiva, an Indian environmental activist, goes further, claiming the use of GM cotton has had a devastating impact on farmers who have become dependent on seeds produced by large foreign-owned corporations. That has killed diversity, she argues, and – since Monsanto bought out most Indian competitors – has forced farmers to buy its seeds rather than buy from the government at subsidised prices.

CHINA : THE PARADOX OF PROSPERITY / THE ECONOMIST ( A MUST READ )

2012-01-28T04:18:00.003-05:00

China

The paradox of prosperity

For China’s rise to continue, the country needs to move away from the model that has served it so well

Jan 28th 2012
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IN THIS issue we launch a weekly section devoted to China. It is the first time since we began our detailed coverage of the United States in 1942 that we have singled out a country in this way.

The principal reason is that China is now an economic superpower and is fast becoming a military force capable of unsettling America. But our interest in China lies also in its politics: it is governed by a system that is out of step with global norms. In ways that were never true of post-war Japan and may never be true of India, China will both fascinate and agitate the rest of the world for a long time to come.

Only 20 years ago, China was a long way from being a global superpower. After the protests in Tiananmen Square led to a massacre in 1989, its economic reforms were under threat from conservatives and it faced international isolation. Then in early 1992, like an emperor undertaking a progress, the late Deng Xiaoping set out on a “southern tour” of the most reform-minded provinces.

An astonishing endorsement of reform, it was a masterstroke from the man who made modern China. The economy has barely looked back since.

The party’s instinct, born out of all those years of success, is to tighten its grip. So dissidents such as Yu Jie, who alleges he was tortured by security agents and has just left China for America, are harassed. Yet that reflex will make the party’s job harder. It needs instead to master the art of letting go.

China’s third revolution

The argument goes back to Deng’s insight that without economic growth, the Communist Party would be history, like its brethren in the Soviet Union and eastern Europe. His reforms replaced a failing political ideology with a new economic legitimacy. The party’s cadres set about remaking China with an energy and single-mindedness that have made some Westerners get in touch with their inner authoritarian. The bureaucrats not only reformed China’s monstrously inefficient state-owned enterprises, but also introduced some meritocracy to appointments.

That mix of political control and market reform has yielded huge benefits. China’s rise over the past two decades has been more impressive than any burst of economic development ever. Annual economic growth has averaged 10% a year and 440m Chinese have lifted themselves out of poverty—the biggest reduction of poverty in history.

Yet for China’s rise to continue, the model cannot remain the same. That’s because China, and the world, are changing.

China is weathering the global crisis well. But to sustain a high growth rate, the economy needs to shift away from investment and exports towards domestic consumption. That transition depends on a fairer division of the spoils of growth. At present, China’s banks shovel workers’ savings into state-owned enterprises, depriving workers of spending power and private companies of capital. As a result, just when some of the other ingredients of China’s boom, such as cheap land and labour, are becoming scarcer, the government is wasting capital on a vast scale. Freeing up the financial system would give consumers more spending power and improve the allocation of capital.

Even today’s modest slowdown is causing unrest. Many people feel that too little of the country’s spectacular growth is trickling down to them. Migrant workers who seek employment in the city are treated as second-class citizens, with poor access to health care and education. Land grabs by local officials are a huge source of anger. Unrestrained industrialisation is poisoning crops and people. Growing corruption is causing fury. And angry people can talk to each other, as they never could before, through the internet.

Party officials cite growing unrest as evidence of the dangers of liberalisation. Migration, they argue, may be a source of growth, but it is also a cause of instability. Workers’ protests disrupt production and threaten prosperity. The stirrings of civil society contain the seeds of chaos. Officials are particularly alive to these dangers in a year in which a new generation of leaders will take power.

That bias towards control is understandable, and not merely self-interested. Patriots can plausibly argue that most people have plenty of space to live as individuals and value stability more than rights and freedoms: the Arab spring, after all, had few echoes in China.

Yet there are rights which Chinese people evidently do want. Migrant workers would like to keep their limited rights to education, health and pensions as they move around the country. And freedom to organise can help, not hinder, the country’s economic rise. Labour unions help industrial peace by discouraging wildcat strikes.

Pressure groups can keep a check on corruption. Temples, monasteries, churches and mosques can give prosperous Chinese a motive to help provide welfare. Religious and cultural organisations can offer people meaning to life beyond the insatiable hunger for rapid economic growth.

Our business now

China’s bloody past has taught the Communist Party to fear chaos above all. But history’s other lesson is that those who cling to absolute power end up with none. The paradox, as some within the party are coming to realise, is that for China to succeed it must move away from the formula that has served it so well.

This is a matter of more than intellectual interest to those outside China. Whether the country continues as an authoritarian colossus, stagnates, disintegrates, or, as we would wish, becomes both freer and more prosperous will not just determine China’s future, but shape the rest of the world’s too.

UNREST IN CHINA : A DANGEROUS YEAR / THE ECONOMIST ( A MUST READ )

2012-01-28T04:17:00.001-05:00

Unrest in China
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A dangerous year
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Economic conditions and social media are making protests more common in China—at a delicate time for the country’s rulers
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Jan 28th 2012 | CHENGDU, DONGGUAN AND WUKAN VILLAGE

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IN AN industrial zone near Chengdu, the capital of Sichuan province in south-west China, a sign colourfully proclaims the sprawl of factories to be a “delightful, harmonious and happy district”. Angry steelworkers must have winced as they marched past the slogan in their thousands in early January, demanding higher wages. Their three-day strike was unusually large for an enterprise owned by the central government. But, as China’s economy begins to grow more sedately, more such unrest is looming.

China’s state-controlled media kept quiet about the protest that began on January 4th in Qingbaijiang District, a 40-minute drive north-east of Chengdu on an expressway that crosses a patchwork of vegetable fields and bamboo thickets. But news of the strike quickly broke on the internet.

Photographs circulated on microblogs of a large crowd of workers from Pangang Group Chengdu Steel and Vanadium being kept away from a slip road to the expressway by a phalanx of police. Word spread that police had tried to disperse the workers with tear gas. In the end, as they tend to—and undoubtedly acting on government orders—factory officials backed down, partially at least. The workers got a raise, albeit a smaller one than they wanted. Managers’ wages were frozen.
Strikes have become increasingly frequent at privately owned factories in recent years, often involving workers demanding higher wages or better conditions. Private firms, like state ones, are usually strong-armed by officials into buying off strikers. The thinking is that capitulating keeps a lid on news coverage and helps to prevent unrest from spreading. Yet the explosive growth in the use of home-grown versions of Twitter has made it easy for protesters to convey instant reports and images to huge audiences. The Communist Party’s capacity to stop ripples of unease from widening is waning—just as economic conditions are making trouble more likely.

Anger at the bottom

At a cheap restaurant in Qingbaijiang, opposite a dormitory compound for Pangang employees, grimy steelworkers complain that the government’s promise of an extra 260 yuan ($41) a month is hardly enough. Many of the lowest-paid earn as little as $190 monthly. But the workers know that the steel industry is struggling—and that vengeance on persistent troublemakers can be fierce. A police notice warns of legal action, including imprisonment, against any strikers who continue “disrupting public order”. Security agents follow your correspondent in an unmarked car.

All this is partly a result of the curb on China’s stimulus spending and carefree (reckless, many would say) bank lending in the wake of the global financial crisis of 2008. There are fewer new construction projects; demand for steel has flattened. Pangang’s plant in Qingbaijiang is running at a loss. The number of steel firms in the red rose from nine in September to 25 a month later. Even though the government is less worried about inflation now than it was a few months ago, and is releasing the economic brakes a little, the steel industry is expecting a lean period. Some firms might have to close.

Overall economic growth is still looking robust. In the final three months of 2011 China’s economy grew by 8.9% compared with the same period a year earlier—enviable by almost anyone else’s standards, though still the slowest since the second quarter of 2009. The slowdown has so far been gentle, and in line with government efforts to prevent overheating. But this does not stop officials worrying that the coming year could be unusually difficult..

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Europe is the biggest buyer of Chinese products—and the euro zone’s travails have plunged many manufacturers into despair. Depressed demand in both Europe and America has taken its toll on factories. The steelworkers’ strike was one of many in recent months, most of them in China’s export-manufacturing heartlands near the coast (see map).

Chinese exporters do not face as big a shock now as they did in late 2008, when the financial crisis caused a sudden collapse in demand and the loss of as many as 20m migrant-labour jobs. But that time China’s recovery was rapid, helped by stimulus spending of 4 trillion yuan (more than $630 billion at today’s exchange rate), as well as developed economies’ own stimulus projects. The impact on migrant workers was further mitigated by the coincidence of the worst of the downturn with the lunar new-year holiday, when most migrants go home for lengthy periods.

This time exporters face protracted slow growth in developed economies, and the risk that the euro zone’s difficulties might worsen. China’s policymakers do not want another lending spree that might burden the financial system with more bad debt, on top of the borrowing accumulated during the previous binge. The country’s relatively low budget deficit (about 2.5% of GDP in 2010) gives it room to spend more on social housing, social security, tax cuts for small firms and consumer subsidies. These could help promote private consumption—eventually.

Nerves at the top

The long-term plan is for China to wean itself off its reliance on exports and investment projects such as roads, railways and overpriced property developments, and for domestic consumption of goods and services to play a much bigger role in fuelling growth. But this rebalancing will be a long, hard slog. Officials do not want shock therapy because it could threaten the jobs of many of the 160m migrants who come from the countryside to provide the cheap labour behind China’s exports.

This economic quandary has become more acute at what is a delicate political moment for the Communist Party. Later this year (probably in October or November), the party will hold its five-yearly Congress, the 18th since its founding in 1921, at which sweeping changes in the country’s top leadership will begin to unfold.

The Congress will “elect” a new 300-member central committee (in fact it will be hand-picked by senior leaders). This will immediately meet to rubber-stamp the appointment of a new Politburo, a body that currently has 25 members. All but two of the Politburo’s nine-member inner circle, the Politburo Standing Committee, will be replaced. Two appointments are all but certain: Vice-president Xi Jinping to take over from President Hu Jintao (as party chief after the Congress and as president next March); and Li Keqiang to replace his boss, the prime minister, Wen Jiabao, also next March. There will be much jockeying for the other slots.

It is a decade since China experienced a leadership changeover on this scale—and the first time since the late 1980s that the advent of a new generation of leaders has coincided with such a troubled patch for the economy. The previous time, in 1988, an outbreak of inflation threw Deng Xiaoping’s succession plans into disarray, giving conservatives ammunition with which to attack his liberal protégés. The party’s strife erupted into the open the following year as students demanding greater freedom gathered in Tiananmen Square.

The threats to the party today are very different, but fear of large-scale unrest still haunts the leadership. The past decade has seen the emergence of a big middle class—nearly 40% of the urban population, as some Chinese scholars define it—and a huge migration from the countryside into the cities. The party takes no chances. Large numbers of plainclothes police are on permanent watch in and around Tiananmen Square. (Since 2008, visitors to the vast plaza have had to undergo airport-type scanning and searches.) Early last year, when anonymous calls began circulating on the internet for citizens to gather in central Beijing in sympathy with the uprisings that were breaking out in the Arab world, the location specified was not Tiananmen but Wangfujing, a shopping street nearby. The police responded by flooding that area with officers too.

In the Pearl River Delta, which produces about a third of China’s exports, there are plenty of signs of malaise. Outside a Taiwanese-owned factory in Dongguan, a dozen or so police officers wearing helmets and carrying clubs watch a small group of angry workers complain that the owner has run away. The factory (which makes massage seats) is unable to pay its debts. They are afraid that, this time, after the lunar new year break they will have no jobs to come back to. A plainclothes policeman tries to silence them. Then a uniformed officer moves in with a video camera, and most of the workers retreat, keeping a prudent silence.

Others in the delta have been less reticent. In November thousands of employees at a Taiwanese shoe factory in Dongguan took to the streets in protest against salary cuts and sackings, purportedly caused by declining orders. Protesters overturned cars and clashed with police. Photographs of bloodied workers circulated on the internet. There have been further protests in recent weeks.

Guangdong province also saw a wave of strikes in 2010. At that time workers—mainly in factories supplying the car industry—were demanding only higher pay and improved conditions. Most of those disputes were quickly and peacefully settled, and rarely involved action on the streets.

The latest spate of confrontations looks different. The steelworkers at the state-owned factory near Chengdu wanted a raise; but, these days, rather than bidding to improve their lots, workers are mostly complaining about wages and jobs being cut. The strikers seem more militant.

A report published this month by the Chinese Academy of Social Sciences (CASS) says that, compared with those in 2010, the strikes of 2011 were better organised, more confrontational and more likely to trigger copycat action. “Workers are not willing this time to accept that they have to make sacrifices for the national good because firstly they have already made enough sacrifices, and secondly, fewer are willing to just pack up and go home,” says Geoff Crothall of China Labour Bulletin, an NGO in nearby Hong Kong.

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Where the heart is

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The government hopes that jobless migrants will return to their home villages, where they or their families still enjoy a tiny land entitlement on which they can subsist, or find work closer to their hometowns. Many will: job opportunities in the interior have grown in the past few years, thanks to a surge of government investment in central and western areas, aimed at evening out economic growth.

Last year Chongqing, a region in south-west China which had long exported large numbers of workers to the coast, for the first time employed more of its surplus rural workforce locally than it sent to other areas. Chongqing’s party chief, Bo Xilai, is believed to be a contender for the Politburo Standing Committee. He has been trying to turn Chongqing into a model for the absorption of rural labour into cities, a project that has involved vast spending on low-cost housing to accommodate the region’s migrants.

But rising numbers of migrant workers in big cities—more than 60% according to the National Bureau of Statistics in 2010—are themselves the offspring of migrants and have no experience of agricultural life. They regard themselves as urbanites, even if they are excluded from many of the welfare benefits to which city-dwellers are entitled. They are better educated than their parents’ generation, and more assertive. A riot by migrants last June in Dadun, another factory town in Guangdong where many of the country’s jeans are produced, hinted at the problems China could face if second-generation migrants lose hope. The manhandling of a pregnant woman by security guards prompted two days of violence, with thousands of migrants setting fire to vehicles and government buildings. Strikes in coastal factories now mainly involve second-generation migrants, according to the report by CASS.

Such unrest is not about to topple the party. As Chinese officials nervously digest the implications of unrest in the Arab world, demonstrations in Russia and an easing of repression in Myanmar, they draw comfort from the consistency of Chinese opinion polls. These appear to show high levels of trust in the central leadership and of optimism about the future under party rule. Many ordinary Chinese are contemptuous of local authorities, but still believe that leaders in Beijing are benign.

The power of weibo

But according to Victor Yuan of Horizon, a polling company in Beijing, citizens’ satisfaction with their own lives and confidence in the government, though high, experienced a “big drop” in 2010 and didn’t recover last year. Confidence in the government has fallen by about 10 percentage points, to around 60%.
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Mr Yuan says the rapid spread of microblogs has contributed to this decline. By the end of last year, weibo, as Chinese versions of Twitter (itself blocked in China) are known, were used by nearly half of the 513m Chinese who had accessed the internet in the previous six months (see chart).

This was slightly more than the number who used e-mail and a rise of nearly fourfold over the year before, according to the government-affiliated China Internet Network Information Centre. Li Chunling of CASS estimates that 90% of urban internet users under 30 are microbloggers.

Weibo have transformed public discourse in China. News that three or four years ago would have been relatively easy for local officials to suppress, downplay or ignore is now instantly transmitted across the nation.

Local protests or scandals to which few would once have paid attention are now avidly discussed by weibo users. The government tries hard, but largely ineffectively, to control this debate by blocking key words and cancelling the accounts of muckraking users. Circumventions are easily found. Since December the government has been rolling out a new rule that people must use their real names to open accounts. So far, users seem undeterred.

In the build-up to the 18th Congress, China’s leaders will become especially anxious to prevent embarrassment to the party. Weibo are likely to make their lives a lot more difficult—at least that was the lesson from a ten-day stand-off in December between police and residents of the coastal village of Wukan in Guangdong.

The villagers’ protest was typical of thousands that roil the Chinese countryside every year: a complaint about the seizure of agricultural land by local officials for private redevelopment. Unusually, however, in Wukan citizens took control of their village and drove out party hacks and police. Officials were alarmed by images that circulated on weibo of triumphant residents rallying in the centre of their village, like students in Tiananmen Square 22 years ago (see the picture at the start of this piece). They tried, unsuccessfully, to stop news spreading by ordering a block on the village’s name and location.

The villagers gave up their protest on December 21st after a rare, high-profile intervention by the Guangdong party leadership, which promised to look into their complaints. Remarkably, on January 15th the protest leader, Lin Zuluan, was appointed as the village’s new party chief (the previous one having disappeared, it is thought into custody). Even the party’s main mouthpiece in Beijing broke its silence on the issue, saying it showed that local officials should stop treating citizens as adversaries.

Wang Yang, Guangdong’s party chief, who is believed to be a contender for a senior Politburo position this year, said the incident demonstrated how people’s “democratic consciousness” was getting stronger. He called on officials not to ignore citizens’ concerns.

Few regard the Wukan episode as a turning point for the party. At least one protester on Tiananmen Square has since been seen being dragged away by police in the usual fashion. But it has stirred debate, online at least, about how the party should respond to protests and other forms of public pressure. And villagers in Wukan warn that they will not be satisfied until they have reclaimed their land. One protest leader says there could be another, “even bigger” uprising.
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Not everyone has a home to go to

The new leadership that will take over after the upcoming Congress will quickly face tests of its ability to handle social unrest. Even if the country does not appear on the brink of an Arab-style upheaval, many Chinese academics say the next few years could see burgeoning instability, exacerbated by slower economic growth and a widening gap between rich and poor. China’s outgoing leaders have tried to suppress debate about ways of reforming the political system to allow the public to voice their grievances more freely. But many analysts believe there is a pressing need for such reform. Today’s “China model”, as some in China and abroad were tempted to call it after Western economies fell into disarray three years ago, appears increasingly unsustainable.

Chinese roulette

An intriguing glimpse of how at least some in the party elite might see things was offered last April when Zhang Musheng, a prominent intellectual, published a book calling for a revival of the one-time Maoist goal of building a “new democracy”. General Liu Yuan, the son of Liu Shaoqi who was China’s president during the Mao era, openly backed the idea. Mr Zhang (himself the son of a late senior official, as are several of the new leaders-to-be) said a new democracy would involve continued party rule but with much greater freedom.

Few of China’s liberals believe there is much chance of any leader pursuing this idea in the near future. But Mr Zhang’s description of China today has struck a chord (and has been circulated widely by weibo users). A well-known economist, Wu Jinglian, picked up a phrase of Mr Zhang’s in an essay in Caijing, a Beijing magazine, in which he attacked the notion of a “China model” and called for political reform. The phrase of Mr Zhang’s that made an impression was one describing China as “playing pass the parcel with a time bomb.”