Will Americans Become Poorer?

Martin Feldstein
. Wall Street New York City

CAMBRIDGE – Robert Gordon of Northwestern University has launched a lively and important debate about the future rate of economic growth in the United States. Although his book The Rise and Fall of American Growth will not be published until January 2016, his thesis has already garnered coverage in the Economist and Foreign Affairs. Clearly, Gordon’s gloomy assessment of America’s growth prospects deserves to be taken seriously. But is it right?
Gordon argues that the major technological changes that raised the standard of living in the past are much more important than anything that can happen in the future. He points to examples such as indoor plumbing, automobiles, electricity, telephones, and central heating, and argues that all of them were much more important for living standards than recent innovations like the internet and mobile phones.
I agree with Gordon that I would rather give up my mobile phone and even the Internet than go without indoor plumbing and electricity. But that just means that we are lucky to be living now rather than a century ago (and even luckier to be living now than two centuries ago or in the middle ages).
The fact that these major innovations happened in the past is not a reason to be pessimistic about the future.
Gordon also points to the recent slowdown in real (inflation-adjusted) GDP growth. According to official US statistics, real GDP per worker grew at an average annual rate of 2.3% from 1891 to 1972, but by only 1.5% since then.
But the official statistics on GDP growth fail to capture most of the gains in our standard of living that come from new and improved goods and services. That means that the official growth rate does not reflect the rise in real incomes that came with air conditioning, anti-cancer drugs, new surgical procedures, and the many more mundane innovations. Moreover, because the US government does not count anything in GDP unless it is sold in the market, the vast expansion of television entertainment and the introduction of services like Google and Facebook have been completely excluded from the national account.
This means that the true rise in real incomes was actually faster than the official statistics imply – possibly much faster. That is true of the data for the first half of the twentieth century, and it continues to be true today. It is not clear whether the measurement problem was bigger in the more distant past than it has been recently; but it is irrelevant when we think about the future.
Whether growth in per capita income that is officially estimated at 1.5% is in reality more like 3%, we are enjoying the higher level of real incomes inherited from the past. So will future generations.
Indeed, there is simply no reason for the view, often expressed in surveys and appearing in Gordon’s book, that the children of today’s generation will not enjoy a standard of living as high as their parents’. That may be true for some people, especially those with relatively high incomes, but it is definitely not true for most people.
Think about a 30-year-old new parent at the middle of the income distribution. Thirty years from now, the child will be as old as her median-income parent is now. If real incomes grow at just 1.5% a year, the median income 30 years from now will be nearly 60% higher than the income of today’s median-income individual.
Even if the child earns 30% less than the median at that time, her income would still be higher than today’s median income. And if product innovations and improvements imply that per capita real incomes grow at 3% a year, the median income of someone 30 years from now would be more than twice today’s median income.
So Americans are lucky that they have inherited the innovations of the past, and that real incomes will continue to grow in the future.
But that is not a reason for complacency. The US can increase its future growth rate by improving its education system, raising its rates of saving and investment to where they were in the past, and fixing the features of its tax and transfer systems that reduce employment and earnings.
Gordon focuses on the effect of technological innovation on Americans’ real incomes. But an important limitation of his argument is that it gives short shrift to policy innovation. America’s economy – and those of many other countries – could grow faster in the future if policymakers adopt the appropriate reforms.

China risks an economic discontinuity

Many believe the economy is already growing far more slowly than the government admits
James Ferguson illustration©James Ferguson

David Daokui Lee, an influential Chinese economist, has argued that: “The stock market sell-off is not the problem . . . the problem — not a huge one, but a problem nonetheless — is the Chinese economy itself.” I agree with both points, with one exception. The problem may prove huge.

Market turmoil is not irrelevant. It matters that Beijing has spent $200bn on a failed attempt to prop up the stock market and that foreign exchange reserves fell by $315bn in the year to July 2015. It matters, too, that a search for scapegoats is in train. These are indicators of capital flight and policymaker panic. They tell us about confidence — or the lack of it.
Nevertheless, economic performance is ultimately decisive. The important economic fact about China is its past achievements. Gross domestic product (at purchasing power parity) has risen from 3 per cent of US levels to some 25 per cent (see chart). GDP is an imperfect measure of the standard of living. But this transformation is no statistical artefact. It is visible on the ground.

The only “large”(bigger than city state) economies, without valuable natural resources, to achieve something like this since the second world war are Japan, Taiwan, South Korea and Vietnam. Yet, relative to US levels, China’s GDP per head is where South Korea’s was in the mid-1980s. South Korea’s real GDP per head has since nearly quadrupled in real terms, to reach almost 70 per cent of US levels. If China became as rich as Korea, its economy would be bigger than those of the US and Europe combined.

This is a case for long-run optimism. Against it is the caveat that “past performance is no guarantee of future performance”. Growth rates usually revert to the global mean. If China continued fast catch-up growth over the next generation it would be an extreme outlier .
In emerging economies growth tends to be marked by “discontinuities”. But what Chinese policymakers call the “new normal” is not itself such a discontinuity. They believe they have overseen a smooth slowdown from annual growth of 10 per cent to still-fast growth of 7 per cent. Is a far bigger slowdown possible? More important, would this be a temporary interruption, as in South Korea in the late 1990s crisis — or more permanent, as in Brazil in the 1980s or Japan in the 1990s?

There are at least three reasons why China’s growth might suffer a discontinuity: the current pattern is unsustainable; the debt overhang is large; and dealing with these challenges creates the risks of a sharp collapse in demand.

The most important fact about China’s current pattern of growth is its dependence on investment as a source of supply and demand (see charts). Since 2011 additional capital has been the sole source of extra output, with the contribution of growth of “total factor productivity” (measuring the change in output per unit of inputs) near zero. Moreover, the incremental capital output ratio, a measure of the contribution of investment to growth, has soared as returns on investment have tumbled.

The International Monetary Fund argues: “Without reforms, growth would gradually fall to around 5 per cent with steeply increasing debt.” But such a path would be unsustainable, not least because debts are already at such a high level. Thus “total social financing” — a broad credit measure — jumped from 120 per cent of GDP in 2008 to 193 per cent in 2014. The government can manage this overhang. But it must not let the build-up restart. The credit-dependent part of investment has to shrink.

The debt overhang is not the only reason why investment will wilt. Daniel Gros of the Brussels-based Centre for European Policy Studies shows that the ratio of capital to output in China is on an explosive path. Remarkably, it is already far higher than in the US. If the capital-output ratio is merely to stabilise at current levels, and the economy is to grow at about 6 per cent, the investment share in GDP needs to fall by about 10 per cent. If that were to happen suddenly, the impact on demand would cause a slump. An investment share of 35 per cent of GDP (merely back to where it was in the early 2000s) would be a desirable outcome of reforms. But moving there swiftly would take a huge bite out of today’s domestic demand.

Many believe the economy is already growing far more slowly than the government admits. But the weaker the prospective rate of growth and the more uncertain are returns, the more rational it becomes to postpone investment, further slowing the growth of the economy.
The core argument for a discontinuity is that it is hard to move smoothly from an unsustainable path. The risk is that the economy slows much faster than almost anybody now expects. The government needs to work out a way of responding that does not increase global or domestic disequilibria. The best approach would be to continue with reforms, while trying to put more spending power into the hands of consumers and investing more in public consumption and environmental improvements. Such a response would be fully in keeping with China’s needs.

A discontinuity in China’s economic growth is now more likely than for decades; such a discontinuity might not be brief; and the challenge facing policymakers is huge. They need to re-engineer a slowing economy without crashing.

Moreover, the challenge is not only, or even mainly, technical. A big question is whether a market-driven economy is compatible with the growing concentration of political power. The next stage for China’s economy is a conundrum. Its resolution will shape the world.

Infrastructure in the rich world

Building works

An historic opportunity to improve infrastructure on the cheap is in danger of being squandered

Aug 29th 2015

IT IS hard to exaggerate the decrepitude of infrastructure in much of the rich world. One in three railway bridges in Germany is over 100 years old, as are half of London’s water mains. In America the average bridge is 42 years old and the average dam 52. The American Society of Civil Engineers rates around 14,000 of the country’s dams as “high hazard” and 151,238 of its bridges as “deficient”.

This crumbling infrastructure is both dangerous and expensive: traffic jams on urban highways cost America over $100 billion in wasted time and fuel each year; congestion at airports costs $22 billion and another $150 billion is lost to power outages.

The B20, the business arm of the G20, a club of big economies, estimates that the global backlog of spending needed to bring infrastructure up to scratch will reach $15 trillion-20 trillion by 2030.

McKinsey, a consultancy, reckons that in 2007-12 investment in infrastructure in rich countries was about 2.5% of GDP a year when it should have been 3.5%. If anything, the problem is becoming more acute as some governments whose finances have been racked by the crisis cut back. In 2013 in the euro zone, general government investment—of which infrastructure constitutes a large part—was around 15% below its pre-crisis peak of €3 trillion ($4 trillion), according to the European Commission, with drops as high as 25% in Italy, 39% in Ireland and 64% in Greece. In the same year government spending on infrastructure in America, at 1.7% of GDP, was at a 20-year low.

This is a missed opportunity. Over the past six years, the cost of repairing old infrastructure or building new projects has been much cheaper than normal, thanks both to rock-bottom interest rates and ample spare capacity in the construction industry. Simon Rawlinson of Arcadis, an infrastructure consultancy, reckons building costs in Britain, for example, were 20% lower in the aftermath of the financial crisis. The market upheaval of recent weeks may delay the first post-crisis interest-rate rise in America by a few months, but construction costs have been rising in America and Britain, among other places, as their economies have strengthened and unemployment has fallen.

Investment in infrastructure can provide a tremendous boost to an economy. The most striking examples are in emerging markets: paving roads has helped double school attendance by girls in Morocco; improved sanitation has helped reduce child mortality in India by over 50%. But the impact in rich countries is also great. Standard & Poor’s, a rating agency, reckons that the activity spurred by increasing government spending on infrastructure by 1% of GDP would leave the economy 1.7% bigger after three years in America, 2.5% bigger in Britain and 1.4% in the euro zone.

A few countries have stepped up spending: investment in infrastructure in Canada rose from 2.5% of GDP a year in 2000-06 to 3.3% in 2007-12. State governments in Australia have made their money go further by leading the early, riskier stages of projects and then privatising them once operational, freeing up capital for the next scheme. (As an extra incentive the federal government now even tops up states’ proceeds from asset sales by 15% if they are reinvested in infrastructure.) In 2012, for example, Ontario Teachers’ Pension Plan and Hastings, a fund manager, bought a 50-year lease on a recently completed desalination plant near Sydney from the government of New South Wales.

But many other governments have failed to follow suit. The so-called “Juncker Plan”, which is supposed to mobilise €315 billion of mostly private investment in infrastructure in Europe, was announced with great fanfare last November; the website listing possible projects has yet to be launched. Planning constraints play their part: it takes four years just to get the permits for the average European power project, according to McKinsey. Crossrail, a new train line running under London, was first mooted in 1974 but is not due to be completed until 2018. Despite the risk of white elephants such as Ciudad Real Central Airport in Spain, which closed only a few years after opening, politicians still tend to prioritise eye-catching schemes over duller but more practical ones. America’s post-crisis stimulus package dedicated $8 billion to high-speed rail, but only $1.5 billion to small, worthwhile projects nominated by state governments.

Yet none of this should impede spending on maintenance, for which there is also a huge backlog. Mending leaking pipes, filling potholes and painting bridges is unlikely to lead to a popular uprising.

There is also lots of scope for modernisation without undue disruption: adding a layer of plastic on top of an asphalt road can increase its lifespan by a third. Investments in technology can make better use of existing infrastructure without adding a brick. New digital monitoring systems, for example, have increased the capacity of Frankfurt Airport from 150,000 passengers a day to 200,000, by providing advance warning of impending bottlenecks.

Such repairs and improvements typically yield higher returns than more grandiose projects.

They are also much quicker to initiate. Western politicians searching for a way to pep up growth in light of the current uncertainty about the health of the world economy need look no further.

The Fed Spent $23 Billion In 3 Days, But Still Had A Hard Time Pushing Up Stocks

  • On Monday, August 24th, the Fed injected $18.54 billion from a "reverse repo fund" filled with cash accumulated at the end of QE3.
  • The $18.54 billion was exponentially greater than what has been previously needed to stabilize stock prices.
  • On Monday & Tuesday, primary dealers failed to move stocks up, because overhead resistance was too strong, and a tactical retreat left the DOW down by a combined 793 points.
  • On Wednesday, the Fed added $4.446 billion, and combined with a mildly positive durable goods report, the primary dealers succeeded in pushing the DOW upward by an astounding 620 points.
  • A September rate hike is off the table, but soon the Fed will have to accept a huge drop in stock prices or a return to money printing.

There was a time, pre-2007, when the Fed could move the DOW up or down by 100-200 points merely by injecting or withdrawing a few hundred million dollars. The idea of injecting a whopping $18.54 billion, in one single day, was something that would have been impossible to imagine. Times change...

On Monday, August 24, 2015, the Fed injected more than $18 billion dollars. In spite of that, the DOW dropped by 588 points, and by the end of trading on Tuesday, it was down a combined 793 points for the two days. What I am talking about? I am talking the sudden failure of the traditional methods that the Federal Reserve uses to control the behavior of millions of investors.

How they injected new money into the market, without actually printing any new money yet, requires a discussion of the little known concept of something called "TOMOs" and "REVERSE TOMOs". At the end of QE3, the Fed collected just over $100 billion of the then-newly-printed dollars into a fund composed of "REVERSE TOMOs". As you will see, REVERSE TOMOs work exactly opposite to the manner in which TOMOs work. So, to avoid confusing you, I must get into a discussion of what these two things are.

The Fed has been pushing markets upward by actively printing a lot of money ever since 2001.

The first phase of the printing extravaganza was not called "QE" because, theoretically, the money that was printed was not permanent. Non-permanent money printing is called a "temporary open market operation" a/k/a "TOMO" a/k/a "repo transaction". "QE" is something different. It is officially known as a "permanent open market operation" a/k/a "POMO". To understand what I am talking about, I have to start talking about an area of finance which is somewhat confusing.

TOMOs, or "repo loans" can be thought of as a type of temporary QE. The central bank prints up a quantity of money, usually at the request of its primary dealers, the dealers take the money, and they hand over bonds in return. The money is used for whatever the big banks want to use it for. In practical terms, it is used for influencing stock, bond and commodity price both up and down, depending on Fed policy.

Another transaction, used by the Fed and its dealers is the so-called "reverse repo" or "REVERSE TOMO". In this type of operation, the central bank hands back the bonds, and the primary dealers hand back the money. The process of using TOMO and REVERSE TOMOs to move prices involves catalysis, rather than brute force. Neither the Federal Reserve, nor any other central banker for that matter, has the resources to fight the entire market.

Careful coordinated use of cash, however, can catalyze changes in market pyschology, and that is often enough to change momentum. The primary dealers use the cash to basically "paint the tape", so that patterns are created which provide buy and sell signals to other investors. This allows the Fed to move markets broadly up and down.

Unlike the case with outright QE (POMO's), primary dealers are actually supposed to pay back TOMOs. The repayment myth is why very few people screamed and yelled, between 2001 and 2007, when this method of money printing was the primary one used to fund a rising stock market, and between 2007 and 2009 to slow down the collapse. It was much less controversial than QE because, theoretically, when the money is repaid, it disappears from the system.

Theory, however, often doesn't work in practice, as we'll discuss in a moment. But, before we get into the repayment issue, it is worth a look at how the Fed describes the process:
Among the tools used by the Federal Reserve System to achieve its monetary policy objectives is the temporary addition or subtraction of reserve balances via repurchase and reverse repurchase agreements in the open market. These operations have a short-term, self-reversing effect on bank reserves.
It is hard to remember all the various names for these transactions. Remember, that a "repurchase agreement" results in a TOMO, and a "reverse repurchase agreement" results in a REVERSE TOMO. The idea that these "loans" are "self-reversing" is deceptive. It is only true if they are repaid in a timely manner. If not, the end result is the same as outright QE.

Between 2001 and 2007, TOMOs and REVERSE TOMOs were used as a primary method of pushing markets up and down.

As you may note from the quote, the Fed alleges that the loans are "overnight", implying they are paid back the next day. That cannot be further from the truth. Almost every morning, going back several decades, the Fed has kept itself very busy, by making new "loans" as great or greater than the ones before. The primary dealers repay the first "loan" with the second, the second with the third, and so on and so forth.

The bottom line is that the Federal Reserve does not get paid back for these allegedly "overnight" loans on the next day. Instead, they get renewed by the issuance of new loans, day after day, week after week, and month by month. That way, the dealers can carry out Fed policy until they can finally make money off the money by pressuring markets in the desired direction.

The Fed balance sheet shows an ever-growing balance of repo "loans" given out between 2001 and 2009. Eventually, they amounted to a running balance of hundreds of billions of dollars, constantly rolled over at maturity for almost a decade. It was essentially a Ponzi scheme, except that the central bank was running it, so it could never break down. Instead, it facilitated an endless expansion of the money supply. This manifested mainly in asset inflation, but was also paid for by commodity inflation during the first decade of the 21st century.
According to the Federal Reserve website:
The Fed uses repurchase agreements, also called "RPs" or "repos", to make collateralized loans to primary dealers. In a reverse repo or "RRP", the Fed borrows money from primary dealers. The typical term of these operations is overnight, but the Fed can conduct these operations with terms out to 65 business days.
Remember, repurchase agreements are TOMOs. "Collateralized" is a fancy way of saying that bonds are posted before the Fed gives out the cash. On maturity, the dealers are theoretically supposed to take their bonds back. But, between 2001 and 2009, the Federal Reserve's balance sheet showed an ever-ballooning mass of repo loans. The loans were never paid back. They were simply renewed, over and over and over again.

The running total of hundreds of billions in repo loans was finally repaid ONLY when the primary dealers received newly printed cash when the Fed started admitted to doing permanent cash printing ("QE"). This gradual process began in March 2009. You can review the entire history of the Fed's repo injections, a/k/a "temporary open market operations" a/k/a "TOMOs" here.

When you compare each TOMO to the movement of the DOW, S&P500 and NASDAQ, you will find a very strong correlation between large cash TOMO injections and "up" days. The "T" in TOMO stands for temporary, even though the loans are more or less permanent gifts.

As with POMOs (QE), money is printed, and, as with POMOs (QE) there is an excellent correlation between injection of cash and a rise in stock and bond prices. The correlation is not perfect, of course, because other factors, like a fantastic news day, can offset the need to inject new money, or even allow some to be taken out.

Once QE began, the TOMO process became irrelevant, and was eventually phased out, because the primary dealers no longer needed them. The process of open and obvious money printing provided them with a permanent source of ready cash, and a market for bonds that could not be profitably sold into the free market. The primary dealers have been very successful in using both the TOMOs and the POMOs to catalyze upward movement in stock and bond markets.

In light of that success, retail investors returned to the market, en masse, during the last phase of QE3. In the midst of that euphoria, not all the printed money needed to be injected right away, and the Fed did some REVERSE TOMOs, holding back some of the newly printed QE money, putting together a sort of emergency reserve fund. Remember, REVERSE TOMOs are the opposite of TOMOs. Money was printed in the POMO (QE) process, and then, because it wasn't needed immediately, it was taken back in the REVERSE TOMO process.

In the end, a fund was created that is essentially a collection of surplus cash, left over from QE3. The existence of this pool of money has allowed the Fed to operate in markets, over the last year, injecting and remove liquidity, without being accused of money printing. Remember, in a TOMO, the Fed takes in bonds and gives out cash. In a REVERSE TOMO, it takes in cash and gives out bonds. Again, if you look at the history, on the days the Fed was accumulating the reverse repo cash fund, stocks mostly went down. Whenever the Fed releases cash from the fund, stocks mostly go up or stabilize if they are going sharply down.

The "REVERSE TOMO RESERVE FUND", as I will call it, is a running balance of REVERSE TOMOs, amounting to somewhere between $65 and $120 billion dollars depending on the day.

Remember, the fund is composed of REVERSE TOMOs, not TOMOs. Therefore, when the size of the fund goes down, it means that the Fed has injected cash into the system. Similarly, when the size of the fund increases, it means the Fed has taken cash out.

When you look at the numbers, remember one critical point. REVERSE TOMOs operate in exactly the opposite way the TOMOs did during the period 2001 to 2007. The fund that is being deployed is not made up of newly printed cash. It is made up of excess money that was printed up at the end of QE3 but not used back then. The Fed reacts to falling markets by releasing cash from the fund.

Take a look at the history and you'll quickly discover that stock prices rise when cash is released (the REVERSE TOMO dollar amount will fall as a result) and stock prices fall when cash is taken back into the fund (the REVERSE TOMO dollar amount will rise when cash is taken back). The end result has been to stabilize the stock market at approximately the same level as a year ago. This convinced the average Joe Investor that the good times are here to stay.

Unfortunately, times change. There has never been a successful centrally planned economy in the history of the world. It didn't work for the old Soviet Union, and it won't work for America.

The intense effort to micromanage the American economy, undertaken over a period of several decades, is also due to fail. It is only a question of when, not if.

In "olden times" (pre-2008), injection in the range of $23 billion would catalyze a massive 2,000 point "up" day on the DOW. That's why it was never done. But, now, the Fed is dealing with the implosion of a boom set into motion by a credit bubble it created. It is a whole new ballgame. The dealers and the Federal Reserve, however, seem to have underestimated how much money they needed to reserve, at the end of QE3, in their "Reverse Repo Reserve Fund".

They also seem to have underestimated the amount of cash it would take to change the market's momentum this past Monday and Tuesday.

In spite of injecting $23 billion, the DOW (NYSEARCA:DIA) still collapsed by 588 points, S&P500 (NYSEARCA:SPY) by 78 points, and the NASDAQ (NASDAQ:QQQ) by 170. It was not a total failure. Not yet. Remember, on Monday, the DOW was down by 1,078 at one point. I

t closed down only 588 points. It was fascinating to watch the events unfold. In the early morning, stocks plummeted in almost a straight line. Then, as banks anticipated receipt of the cash, typically delivered at 1:15 pm, stocks recovered.

Stocks reached a peak around the exact time the money was delivered by the Fed. But, when the money actually arrived, the "buyers" began trying to sell. Closing long positions in an orderly manner is essential for the success of a upwardly bound market manipulation. It could have been done, if the dealers had been able to create such chaos. But, it didn't work. Stocks began to head downward again.

In the first part of the last half hour of trading, the longs (I surmise that they are the primary dealer controlled hedge funds) seemed to make a last-ditch effort to catalyze upward momentum. Yet, in an intensely negative sentiment situation, one must quickly sell long positions, or risk getting stuck with big losses. The buyers seemed to try desperately to cover longs before the end of the trading day.

It didn't work again. Once the longs tried to sell, stocks raced down in the last 10 minutes or so of the trading day. It was fairly obvious on Tuesday, the next day, that the Fed was far from finished. The dealers may have staged a tactical retreat on Monday, but they were armed and ready. The futures market was bid up heavily in the early morning hours, and that the indexes were looking spectacular.

As the cash market began trading, however, sellers took over again. The intensity of the selling ended up foiling the longs. Again, the attempt to catalyze upward market movement failed. The DOW ended up down by 205 points. On Wednesday, with the addition of another $4.446 billion in ammunition from a reduction in the reverse repo fund, they finally found success.

The day started off well, with some good news about durable goods. Then, various voting members of the FOMC began telling the public that a September rate hike was "less compelling". The combination of a bit of good news, Fed official jawboning, and with a dollop of extra cash to capitalize on it, the dealers managed to raise the DOW by 619 points.

It will be impossible to maintain this momentum without huge additional cash injections. This is illustrated by the fact that the ISE Sentiment Index, which indicates how many real investors want to buy stocks, printed at a sad 79 at the end of the big rally Wednesday. In other words, the rally was contrived, and additional upward catalysis operations will require larger and larger sums of cash.

All of this leaves the Fed in a pickle. Throwing $23 billion at a falling market, didn't stop the decline of stock prices. If they throw in another $23 billion, every three days, stocks will be suspended for longer, or will fall by a only a mediocre amount. But, this cannot go on forever.

The current "reverse repo fund" has already been drained down to $68.719 billion. That's only enough for a few more trading days. Once it is drained down to zero, the Fed is out of ammunition.

At the zero point, they will be forced to return to either overt money printing (QE) or the covert money printing (TOMOs that are never paid back). Otherwise, there will be a very large percentage decline in virtually all the indexes. We will see either a Great Depression style stock collapse, or a new money printing program. Since "QE" is now a dirty word, they will call it something else. Probably, they will go with the covert TOMO route. In the end, however, it is all the same. They will print money.

Between now and then, you could lose a lot of money. During the period 2001-07, the daily cash TOMO injections typically amounted to only a few hundred million dollars. Now, the injections will have to be exponentially greater. At $20 billion a pop, people will begin to notice, regardless of how covert the Fed tries to behave. The end result will be a loss of confidence in the Federal Reserve.

Money printing, however you call it, has a profound effect on precious metal prices. From 2001 to 2009, for example, when TOMOs were used exclusively, gold more than tripled in response to a substantial increase in the money supply. Later, when the POMOs (QE) began, gold soared to $1,900. Both money printing methods put heavy upward pressure on precious metals prices.

The current administration seems dead set on stopping gold from being a "canary in the coal mine" that lets investors know what is really going on. It appears to have taken the role as "supplier of last resort" in the gold market. Admittedly, it has thousands of tons of the yellow metal. Theoretically, US-owned gold could feed markets for a long time, filling excess demand, and restraining prices against their natural tendency to rise. But, not even America has unlimited resources.

Filling even the current level of supply deficiency will drain the gold reserve to zero in only a few years. And, with the probable loss in confidence in the Fed, the drain will increase exponentially. The gold reserve might not even last a year after that. It is unlikely that the powers that be, desperate though they may be, will risk everything. They are well aware that gold reserves may be critical in the new monetary world that finally unfolds after this crisis is over.

Precious metals prices will eventually rise dramatically. It is just a question of whether it happens this year or 2-3 years in the future. That's why, right now, buying gold as a long term hedge is your best bet. For those caught still holding stocks, however, the good news is that more cash injections are on the way. It is the only method that the Fed can use to offset the speed by which stocks are falling and it will happen until the Reverse TOMO Reserve Fund is entirely exhausted.

About $68.719 billion remains and it will be used before the Fed considers any more money printing. It is reasonable to expect that a combination of cash injection, jawboning and hyping up of stray pieces of good news will be used, in the near future, to catalyze additional up days.

Some of them may be very large as the Fed opts for a "shock and awe" campaign. Don't be shocked or awed. Get ready to use the opportunity to sell. The long term future is dismal.

Absent money printing, there will be a very large decline in stock prices. We do not yet know the timing. If the decision is to print more money, as is likely, stocks will rise when looked at in nominal terms. However, the Fed will lose so much credibility that the value of the dollar will be greatly impacted. For that reason, a significant delay in making that decision will probably occur. Stocks must fall first, and the techniques they are now using must be proven to be a definitive failure.

It is prudent to use these artificial rally days to get out before the big decline that spurs the Fed into renewed money printing. Then, you can get back in, or choose an alternative investment that will benefit more from the loss of Federal Reserve credibility.

Mass Migration

What Is Driving the Balkan Exodus?

By Susanne Koelbl, Katrin Kuntz and Walter Mayr

 Photo Gallery: Leaving the Balkans Behind

More than a third of all asylum-seekers arriving in Germany come from Albania, Kosovo and Serbia. Young, poor and disillusioned with their home countries, they are searching for a better future. But almost none of them will be allowed to stay.

When Visar Krasniqi reached Berlin and saw the famous image on Bernauer Strasse -- the one of the soldier jumping over barbed wire into the West -- he knew he had arrived. He had entered a different world, one that he wanted to become a part of. What he didn't yet know was that his dream would come to an end 11 months later, on Oct. 5, 2015. By then, he has to leave, as stipulated in the temporary residence permit he received.

Krasniqi is not a war refugee, nor was he persecuted back home. In fact, he has nothing to fear in his native Kosovo. He says that he ran away from something he considers to be even worse than rockets and Kalashnikovs: hopelessness. Before he left, he promised his sick mother in Pristina that he would become an architect, and he promised his fiancée that they would have a good life together. "I'm a nobody where I come from, but I want to be somebody."

But it is difficult to be somebody in Kosovo, unless you have influence or are part of the mafia, which is often the same thing. Taken together, the wealth of all parliamentarians in Kosovo is such that each of them could be a millionaire. But Krasniqi works seven days a week as a bartender, and earns just €200 ($220) a month.

But a lack of prospects is not a recognized reason for asylum, which is why Krasniqi's application was initially denied. The 30,000 Kosovars who have applied for asylum in Germany since the beginning of the year are in similar positions. And the Kosovars are not the only ones.

This year, the country has seen the arrival of 5,514 Macedonians, 11,642 Serbians, 29,353 Albanians and 2,425 Montenegrins. Of the 196,000 people who had filed an initial application for asylum in Germany by the end of July, 42 percent are from the former Yugoslavia, a region now known as the Western Balkans.

The exodus shows the wounds of the Balkan wars have not yet healed. Slovenia and Croatia are now members of the European Union, but Kosovo, which split from Serbia and became prematurely independent in 2008, carves out a pariah existence. Serbia is heavily burdened with the unresolved Kosovo question. The political system in Bosnia-Hercegovina is on the brink of collapse, 20 years after the end of the war there. And Macedonia, long the post-Yugoslavia model nation, has spent two decades in the waiting rooms of the EU and NATO, thanks to Greek pressure in response to a dispute over the country's name. The consequences are many: a lack of investment, failing social welfare systems, corruption, organized crime, high unemployment, poverty, frustration and rage.

Losing Confidence

A survey by Germany's Friedrich Ebert Foundation found that close to two-thirds of 14-to-29-year-olds want to leave Albania, as do more than half of those in the same age group from Kosovo and Macedonia. They have lost all confidence in their young democracies, and they dream of a better life.

They apply for asylum in Europe because that is the only way to obtain a residence permit. But almost all applications are ultimately denied. In 2014, 0.2 percent of Serbians were recognized, 1.1 percent of Kosovars and 2.2 percent of Albanians. One of the topics of discussion at the next asylum summit in Berlin on Sept. 9 will be whether Albania, Montenegro and Kosovo should be added to the list of "safe countries of origin" along with Serbia, Macedonia and Bosnia-Hercegovina. The hope is that changing the rules will encourage fewer people to migrate to Germany from the Balkans.

Map: Where the asylum seekers come from.

And there are, indeed, hardly any reasons to grant asylum to migrants from the Balkans. Even human rights organizations have few objections ton classifying these countries as "safe," with the exceptions that apply to minorities like the Sinti and Roma, as well as homosexuals. But is this a way to stop the hopeless from coming? What are people like Visar Krasniqi running away from? And what is political security worth to someone who is poor?

The search for answers takes us to Albania and Kosovo, the two poorest Balkan countries and the sources of the largest number of asylum seekers in recent months. And to Serbia, which has been classified as a "safe country of origin" for the last year.

Kosovo: A Country Like a Cage

Vučitrn is a small city north of Pristina that holds a sad record: Almost a tenth of its of 70,000 people have left for -- or have already returned from -- Germany. The city's largest employer, a galvanization plant, shut down last year and the exodus began soon thereafter. Some residents sold their houses or jewelry to pay for the trip; all went into debt. Suddenly no one wanted to stay in Vučitrn anymore.

The migrants took buses to Subotica on the Serbian-Hungarian border. Then a trafficker took groups of 60 to 70 people at a time on an eight-hour trek through the forest into Hungary, circumventing the border post. "It felt like all of Kosovo was there," says Teuta Kelmende, 30, an attractive woman with high cheekbones and blue eyes. Wiping away a tear, she describes how she pulled her daughter along with her in the coldness of February. She scrolls through photos on her smartphone: of the hotel in Serbia, the train ride to Austria, the family sitting on a bus in the southwestern German state of Baden-Württemberg, bound for a migrant reception camp.

Kelmende and her husband live in the house of her husband's parents in a village near Vučitrn. They own one cow. She dreams of learning to become a hairdresser and he dreams of making more than the €15 a day he takes in driving an illegal taxi. In January, they heard the news on television that Germany was seeking foreign workers and accepting refugees. They borrowed €3,000 from relatives and left.

Their dream ended a few weeks ago, and Kelmende and her husband, like so many others, are back in Vučitrn. On this day, she is sitting in the social welfare office. An international aid organization is looking for an assistant, and Kelmende is hoping to get the job. She is wearing lipstick and a chiffon blouse for the interview.

"We deceived ourselves," says Kelmende, referring to their trip to Germany.

But perhaps that is unsurprising in this small country with a population of only 1.8 million, where one in four people lives on less than €1.20 a day. Two-thirds of Kosovars are less than 30 years old, and 70 percent of them are unemployed. Many families could hardly survive without the €600 million that is annually sent back to family members by the Kosovar diaspora. The payments represent half of the country's gross domestic product.

Bloated Administration

Those who are not part of the system in Kosovo hardly stand a chance to rise out of poverty, despite the fact that Kosovo receives more foreign aid per capita than any other country. The EU pays €250 million alone for the EULEX police and justice mission, which has failed to develop constitutional institutions and in fighting corruption.

The same group of corrupt politicians occupies all top government positions. This has led to the development of a bloated administrative apparatus of about 100,000 employees. The jobs typically go to relatives and supporters of those holding political positions. Public property is treated like private property: Recently, for example, the country's electricity plant was sold at a deep discount to a relative of the Turkish president. Profits are funneled into dark channels and court proceedings drag on forever, with 500,000 cases still awaiting processing.

The country has never investigated what happened to 13,000 people who died in the war, and former officers of the Kosovo Liberation Army (KLA) are now in positions of power. It was only at the beginning of August that parliament approved the establishment of a special tribunal to investigate war crimes.

Kosovars have been liberated from their Serbian oppression since the war ended 16 years ago, and yet they still live in a cage. Kosovo is the only country in the Balkans whose citizens are denied access to Europe and require a visa for the EU. Kosovo is not a member of the United Nations nor is it recognized by all EU countries. It is not even permitted to compete in the football World Cup.

Such was the situation in Vučitrn, and no one was particularly interested whether the news about Germany seeking foreign workers was actually true. No one investigated rumors that traffickers might have put out the information to create false hopes.

This, at any rate, is what the mayor of Vučitrn claims. Bajram Mulaku, 66, a former mathematics professor, is a white-haired giant of a man with a piercing gaze. Sitting at a large conference table in the town hall, he says that drivers, traffickers and hotel owners must have earned more than €10 million from the exodus out of Kosovo. The government in Pristina likewise blames an international trafficking network for the wave of refugees, and police have already arrested 54 suspects.

'We Have a Life'

In spring, Mulaku called upon his citizens to stay home. He spoke of opportunities, of subsidies for potato farmers and of beekeeping. People merely had to be willing to work hard, he said.

But no one wanted to hear that. The number of people leaving the city and the number of traffickers kept increasing, and prices declined by the day. In the end, traffickers were charging only €200 to take people to Hungary. Now everyone wanted to try his luck, if only to see Europe once. More than 100,000 Kosovars have left the country in the last 12 months, including 48,000 in the first three months of this year alone. Most went to Germany and France. Only 13,000 have thus far returned.

Perhaps the government is not entirely opposed to the mass exodus, because the typical migrant is 20 to 34, has no training, is unemployed and earns no more than €450 a month. Kosovo also has the highest birth rate in Europe, and 40,000 people come of age every year, creating even more pressure on the labor market.

Visar Krasniqi doesn't want to go back. He is sitting in Café Oase on Alexanderplatz in Berlin, exhaling smoke from a hookah. He shows us his mobile phone, with an endless list of numbers of Kosovars in Berlin, Germany and all of Europe. They talk on the phone and play soccer, but most of all they compete with one another over which of them will stay in Germany the longest.

And when they are short of funds, they cheer each other up by saying: "We are poor, but we have a life."

In Sweden migrants are deported after only four days, says Krasniqi, but the Finns are more liberal.

In fact, he wants to go to Finland after Oct. 5, the date when his stay in Germany will come to an end.

Albania: Caught Up in the Maelstrom of Emigration

Mali Tafaj is standing in a field, threshing rye, five kilometers from the border with Kosovo. He gathers the dried sheaves, jerks the ears up to the cloudless sky and then slams them against a wooden block to detach the grains. Gathering, jerking and slamming the grain onto the wooden block -- this is the rhythm of Tafaj's days. He has been working in the field since 8 a.m., alongside his sister Baid, his father Bayran and his mother Nadira. They are producing feed for their three cows. The threshing will take eight hours. But there isn't much else to do in Novosej, anyway.

Novosej is a small hamlet in northeastern Albania, with huts made of fieldstone and unpaved streets. Chickens scratch around in the dirt, old men ride by on their donkeys and children tend the sheep. Many years ago, the village had a population of more than 2,000, but now there are only 300 people left. "They are all in Germany," says Tafaj.

A slender 23-year-old man and a fan of AC Milan, he wipes the sweat from his brow. When he enrolled at the university, he listed his top choices of the subjects he wanted to study: 1. Finance, 2. Journalism, 3. Forestry. The government chose forestry for him. Now Tafaj knows the Latin names of all types of local trees, but he doesn't have a job. Albania has a 30 percent unemployment rate.

There are about three million Albanians still living in the country, and about the same number as have already left the country. Albania is ninth in the World Bank's ranking of the ratio of a country's emigrants to its population. In first seven months of this year, 29,353 Albanians applied for asylum in Germany, including 7,500 in July alone. Only about 8,000 applications were filed during all of last year. After Syrians and Kosovars, Albanians have become the third-largest group of asylum seekers in Germany.

The most recent wave of emigration began with a rumor, say the villagers. The rumor, which came from Kosovo, just over a nearby hill, at the beginning of the year, was that the border to Serbia was open and that Germany was looking for workers.

Waiting for a Miracle

Dozens of Tafaj's friends and relatives left the village and drove across the border to Prizren, where they paid €200 to board a bus to Germany. Since the visa requirement was lifted in 2010, Albanians are now permitted to spend three months a year as tourists in the Schengen area. Upon arrival in Germany, they applied for asylum, and now they receive €143 a month in support and are waiting for work. Or a miracle.

Albania is a country of constant transformation: from a communist regime to unrest bordering on civil war to a parliamentary democracy. Albania became a candidate for EU accession a year ago, but it is also a country where human trafficking and organized crime are rampant.

Some 72 bombs tied to criminal, private or political feuds have exploded there since 2014. Entire families are trapped in their homes because of threats of blood revenge. Albania is in 110th place in the Transparency International corruption ranking.

Albania is also the poorest of the 37 European countries for which Eurostat collects statistics. After 1990, agricultural cooperatives were closed and the country's industry was in shambles.

About half of all scientists and academics left the country and roughly one in two Albanians still work in agriculture today. Annual per capita GDP is €3,486, one-eighth of the EU average. The average hourly wage is a little over €2.

But no one is persecuted for criticizing the government. There is no war, the Sinti and the Roma are not hunted down, and even gays and lesbians are tolerated. If Albania is soon classified as a "safe country of origin," it will become easier to deport its citizens. But would that solve the problem?

In the afternoon, we are invited into the home of Mali Tafaj and his family. They live in a simple stone hut, with the parents sharing a room with the little brother, and Tafaj sleeping next to his sister. At night, they talk a lot about emigrating. His sister Badi says: "As a woman, I have to stay. But I want my brother to leave soon."

'For My Parents' Sake'

The Tafajs have an annual income of €3,500. They earn 20 cents from a kilogram of potatoes and €2.50 from a kilogram of veal. "It troubles us that we cannot offer the children a future," says the mother. On the day before, Tafaj spoke with a few emigrants who live in London and are home on vacation. They are well dressed and have brought money from England. Transfers from abroad make up one-tenth of the country's GDP. "I will have to support my parents when they get old," says Tafaj. "But how?"

In a video posted by the German police that he saw on Facebook, a voice says that there are no prospects for asylum in Germany. Tafaj would actually like to stay in Albania. "But I will probably go," he says. "For my parents' sake."

What would Edi Rama say to a young man like Tafaj?

"I know that Germany is tempting," says Rama. "The €11 a day. The temporary work permit.

The ability to save a little money in those three months. All of that is worthwhile for many people." Rama is a tall, jovial man who was once an art professor and used to be the mayor of the Albanian capital city of Tirana. He is now the country's prime minister. His office in Tirana, which doubles as his studio, is a three-hour drive from Tafaj's village. There are wax crayons on the tables. Rama wants to be the one to bring Albania into the EU.

For decades, the country's economy was based on a construction boom and transfers from emigrants. Now it has been diversified to include a textile industry, mining, telecommunications, energy and tourism. "But palpable results take a long time," says Rama.

The reform process has come to a standstill. Tens of thousands protested when the government raised taxes on cigarettes and gasoline, and announced plans to introduce a higher income tax.

People are leaving Albania because change is taking too long for their taste. To prevent more and more people from emigrating, the prime minister is urging the EU to classify his country as "safe" as quickly as possible. He knows that EU accession negotiations will not begin as long as large numbers of Albanians continue to seek asylum in countries to the north.

Rama also has a dream, one that he discussed with German Chancellor Angela Merkel when she visited Tirana in July. He wants Germany to enter into cooperative programs with Albanian trade schools. The schools would deliberately prepare Albanians for the kind of work that no one in Germany wants to do. He calls the idea "a game changer," and adds: "Fifty trade schools, and in three years everything here would be different."

Serbia: Escaping the Winter

Most Balkans immigrants originate from Albania and Kosovo, but one in five is from Serbia or Macedonia, two countries that have been considered "safe countries of origin" since 2014.

Despite this, the number of asylum applications for Serbian citizens has increased by 45 percent compared to the first seven months of 2014. Only 0.1 percent of Serbians have so far been permitted to stay in 2015. So why do they keep coming?

During the first three months of this year, 91 percent of the Serbian asylum-seekers in Germany were Roma, despite the fact that there is less discrimination against Roma in Serbia than in Hungary, the Czech Republic or Slovakia. What drives them is need. "We also want to get a piece of German prosperity -- that's why many are going," says Vitomir Mihajlovic, who is sitting in his office with a view of Belgrade's St. Mark's Church. He's president of the Roma National Council, which, he says represents 600,000 Roma.

He says all the talk in Europe of "asylum cheats" is misleading and what his people are actually looking for is "economic asylum. That means that we aren't fleeing for political reasons, but that we are nonetheless threatened." Mihajlovic says that 80 percent of Serbian Roma haven't even completed primary school and that discrimination creates a vicious cycle of suffering. The marginalization of the people who live in Mahala, a Roma settlement, starts as soon as school for most, and it doesn't take long for a sense of resignation to set in.

Conditions are at their worst during the cold winter months. To prevent people here from heading for Western Europe, Mihajlovic suggests that Germans send wood for heating, food and toiletries and undertake other short-term measures. The clock is already ticking, he warns.

"Things will pick up again in September. Then the next wave will begin making its way north."

Eight People in 12 Square Meters

Halkilk Hasani is among those planning to make that journey soon. The 42-year-old spent nine years working for the garbage collection company, but he's been out of work for a long time now. He lives together with his wife and six children in a 12 square meter (130 square foot) space in Makis 1, an impoverished container settlement at the edge of Belgrade that is surrounded by trash, stray dogs and children who play on the bare earth. At least he lives here for the time being. The city wants to evict the family because they left for Germany in 2011 and, by doing so, forfeited their right to live here.

Their 2011 trip took them by bus from Belgrade to Essen, where they applied for asylum. Around a year later, officials rejected their applications, but they stayed anyway, for another 15 months. "It was like living in America," says Hasani. "We got an allowance of €900 a month as well as food and toiletries." But then, they were cut off. The police showed up one morning at 3 a.m. and drove them to the airport. They were flown back home on an Adria Airways flight from Frankfurt on Feb. 25, 2014. Hasani dug out his ID, which the German federal police stamped with the word "deported". It didn't scare him. "I was told that it is only valid for two years," he explains. He will be permitted to enter Germany again in February and he says his family plans to go again.

Serbian Prime Minister Aleksandar Vucic has some advice for the Germans. "Send our people home again and, more importantly, don't give them any money." There's nothing Vucic could use less right now than trouble with the Germans. The EU lifted the visa requirement for Serbians traveling into the Schengen area in 2009 and it would be a major setback for the prime minister and his policies of opening Serbia, which include cautious overtures to Kosovo and painful economic reforms.

But it's not just Serbian Roma who are heading to Germany. Belgrade has become a transit hub for tens of thousands of Syrians, Afghans and Iranians who are flowing into northern Europe via Turkey and Greece. The EU, their dream destination, is located just 200 kilometers from the Serbian capital and around 2,500 refugees arrive in Serbia every day. Andso many refugees are arriving in neighboring Macedonia that the government declared a state of emergency last Friday.

To send a message, Serbia's prime minister appeared on Aug. 19 in the park behind Belgrade's central station, where thousands of refugees gather prior to the last stage in the trip to Hungary. Just one day earlier, the refugees had been camped out here between mountains of trash, shreds of clothing and excrement. On the morning of the 19th, though, in expectation of the visit, the city's sanitation department cleaned up the park up so that Vucic, surrounded by cameras, could extend his "hospitality and cordiality" to the refugees. Most of those present, though, didn't even know who was speaking, so the prime minister patted a boy on the head and disappeared again.

On Thursday, the Western Balkan Conference is set to begin. Ironically, the meeting will be held inside Vienna's Hofburg Palace, the heart of the former Habsburg Empire. The countries touching the empire's former external borders still haven't found lasting peace even 100 years after it unraveled.

For this year's conference, organizers have come up with something special. In the stadium where the football team Wiener Austria usually plays, heads of current EU member states are to match up against the team "FC Future EU."

That team includes Serbian Prime Minister Vucic, Kosovo Foreign Minister Hashim Thaci and Prime Minister Rama of Albania, men who wouldn't even have shaken hands not too long ago. It would be a good opportunity for these men to bury old hostilities. And to try to find a way to stop the exodus.

Translated from the German by Christopher Sultan

Why the Fed Should Postpone Rate Hikes

Anders Borg

Janet Yellen

JACKSON HOLE, WYOMING – As central bankers from around the world gather this week in Jackson Hole for the Federal Reserve’s annual Economic Policy Symposium, one key topic of discussion will be the current global stock-market turmoil. There are many reasons for these gyrations, but the expectation that the Fed will start to raise interest rates – perhaps as early as September – is clearly one of them.
The arguments for a rate hike are valid. The United States’ economy is gaining traction. The International Monetary Fund forecasts 3% annual growth in 2015 and 2016, accompanied by inflation rates of 0.1% and 1.5%, respectively. When an economy is normalizing, it is reasonable to reduce expansionary measures, such as those introduced after the crisis of 2008.

Because the Fed has clearly communicated that it will move gradually toward less expansionary policies, its credibility would be damaged if it did not follow through.
But there are strong reasons for the Fed to postpone interest-rate hikes and to keep monetary policy expansionary over the coming quarters. For starters, the US recovery remains weak.

Historically, 3% growth during a recovery is far from impressive. In other recent recoveries, growth often hit 4% or even 5% when increased capacity utilization pushed up productivity and investment.
Over the past three decades, the US has been able to grow at an average annual rate of around 2.5%. Some attribute relatively slow growth to demographic factors, which have reduced the labor force, as well as to weak productivity levels, which have been low.
But America’s potential output may be underestimated, and its inflation propensity exaggerated. The US labor market works well. Unemployment is down to 5%, with no signs of overheating. The employment cost index suggests that wage increases so far have been surprisingly low.
One reason for this is that labor-market flexibility increased during the recovery. Self-employment, short-term contracts, or part-time arrangements account for many of the jobs that have been created over the past few years. Full-time jobs with comprehensive benefits are now much rarer. This ongoing “Uberization” of the US labor market means that the balance in the wage-setting process has shifted. As a result, it will take longer for demand to feed through to wages and inflation than in the past.
Moreover, the economy is undergoing an ongoing technological shift stemming from digitization and globalization. Estimates from Citigroup indicate that almost half of all jobs will be disrupted in the coming decades. Jobs that require lower skills and less training are particularly vulnerable; but it is also clear that many other occupational categories – including administration, accounting, logistics, banking, and various service activities – are likely to be affected. Companies will be able to reduce their headcount and production costs while improving customer service, which, like Uberization, will affect the wage-setting process.
Central bankers, I believe, are underestimating the impact of this structural shift. In the more tech-oriented economies, like the US, the United Kingdom, and the Nordic countries, there is a risk that traditional macroeconomic models will overestimate the cost pressure from labor.
Another reason why the Fed should postpone a rate hike is that financial turmoil in emerging markets, particularly China, could have a substantial impact on the global economy, with some clear implications for the US economy. In particular, lower energy and commodity prices are likely to dampen inflationary pressure. When inflation is low for a long period, inflation expectations also tend to be low. Add falling commodity and energy prices to the mix and there is a risk that inflation expectations will remain too low to sustain a balanced recovery.
The global implications of lower emerging-market currencies are also likely to be deflationary.

The direct impact is that a stronger dollar reduces the cost of imported goods. The indirect effect, which might be substantial, is that cost-competitive light manufacturing in emerging markets increases. That would reinforce the deflationary pressure from globalization for years to come.
There is also a risk of greater currency-market volatility if the Fed jumps the gun in raising rates. The Fed’s unconventional monetary policies have been necessary for the US. But, because they flooded global markets with liquidity, large portfolio flows have moved into emerging-market countries, whose currencies often are not as liquid as the dollar. When investment moves back into dollars, the currency fluctuations in these less liquid markets can become excessive.
The Fed clearly has a responsibility to consider how its policy decisions affect the global financial system. Excessive currency volatility is not in America’s interest, not least because large exchange-rate depreciations in emerging markets would amplify the effects of globalization on US jobs, wages, and inflation, particularly as weaker foreign currencies make outsourcing a more economically viable solution.
Another reason for the Fed to reconsider hiking rates is that the legitimacy of the Bretton Woods institutions depends on a well-functioning global financial system. The global economy’s center of gravity is moving to Asia, Latin America, and Africa, but the IMF and the World Bank still seem to mirror the reality of the 1950s. If the Fed is seen as unleashing a major crisis in emerging markets, this will almost certainly do long-term damage to the global financial system.
The Fed should regard lower commodity prices, reduced inflationary pressures, changes in the labor market, and further disruptive technological shifts as sufficiently convincing arguments to postpone a rate hike. Including the risk of excessive volatility in the global financial system tips the balance even further.
There is plenty of time for the Fed to signal that its policy stance has shifted, and the conclave in Jackson Hole is an excellent opportunity to start that communication. If the facts have changed, the policy implications must also change. The greatest loss of credibility always comes when policymakers try to ignore changing realities.

miércoles, septiembre 02, 2015




China Has Another 15% to Fall

Strategists see the Shanghai Composite falling to around 2700 before bottoming out.

By Daniel Shane

Aug. 29, 2015 1:22 a.m. ET

Buckle up! China’s battered, bruised, and bloodied stock market could fall at least another 15% before it hits the bottom.
That’s the call from some top strategists and money managers, who reckon that the Shanghai Composite Index, the flagship benchmark for mainland China stocks, may find a floor around 2700, down from 3230 at Friday’s close. The index fell 8% last week, even after regaining some ground on Thursday and Friday. It is down 40% from its peak in June.
Contrarian-minded investors could be forgiven for wondering whether this is a rare opportunity to swoop in and buy. But if historic price-to-earnings multiples are any guide, China’s rout has yet to run its course.
Investors at a Shanghai brokerage monitor the stock market’s downward trajectory this month. Stocks have been slammed as China growth has slowed. Photo: Johannes Eisele/AFP/Getty Images 
The average stock in the Shanghai Composite now trades at 15 times earnings, a significant fall from the peak of about 22 times in June. But multiples still look rich compared with the 10 times they were trading at last year, before the big bull market took off. The Shanghai would have to fall to about 2700 to return to a P/E of 10.
U.S. stocks, by comparison, have traditionally provided a nice buying opportunity when selloffs pushed the P/E of the Standard & Poor’s 500 to around 12 times.
Francis Cheung, head of China/Hong Kong strategy at broker CLSA, thinks the unwinding of margin financing and selling to free up liquidity will indeed push the Shanghai to 2700, a level last seen in December. Cheung recommends getting in at that point, since the market should be supported by lower interest rates and bargain hunting by fund managers.
BUT HEADLINE NUMBERS don’t tell the whole story. Chinese stocks still range from pretty overvalued to really overvalued, if you take anemic earnings growth into account. Plus, Shanghai’s average P/E is held down by the hefty weighting of blue-chip stocks in the index. State-backed banks Industrial & Commercial Bank of China (ticker: 601398.China), Agricultural Bank of China                (601288.China), and Bank of China (601988.China) account for roughly 11% of the Shanghai Composite, and all trade at four to five times earnings. They all also have a tiny free float, at less than 10% each, compared with the investor free-for-alls at the top end of the index. Subtract these from the mix and the average A-share—yuan-denominated stocks listed in Shanghai or Shenzhen—has a dizzying P/E of 30 or higher, suggesting the broader market is still overvalued.
Other strategists are skeptical about 2700 as a floor. “I’m sure there were plenty of analysts a week ago telling you the floor was 3500,” quips Michael Parker, a Sanford C. Bernstein strategist. He says that for China stocks to bottom, there needs to be evidence of more effective policy making from Beijing than we’ve currently seen. Top of his wish list is for the yuan to stabilize at 6.4 against the U.S. dollar. If Beijing allows the yuan to weaken further, it would be acknowledging that the economy is looking very weak–or that policy makers are incompetent. Neither would impress investors. “The risk is they’ll do something draconian on the currency side,” Parker says.
Some market mavens have cautioned against relying on P/E multiples as a gauge of value for China’s volatile stocks. Magdalene Miller, a portfolio manager with Standard Life Investments, says investors should look at price/book to get a better sense of Chinese stocks’ true value. The P/B ratio measures a company’s tangible assets against its share price.
Miller believes P/B is less susceptible to market volatility than P/E. That’s good, because Shanghai has volatility by the bucket load. Currently, the market trades around 1.7 times average book value, down from 2.7 times at the height. The bottom for Shanghai stocks could be about 1.4 times book. Stocks last traded there in November, when the index was hurtling through 2500. “This should be a good support level,” she says.
The S&P 500, for its part, trades at 2.5 times book. Its peak before the global financial crisis in 2007 was three times, and it bottomed out at 1.4 times a year later.
Still, some Asia market veterans warn that even if valuations fall further, Shanghai is best left to experienced stockpickers. In other words, don’t buy the index. “One thing about the A-shares market is it’s all tarred with one brush,” says Andrew Swan, BlackRock’s head of Asian equities. His exposure to Chinese A shares is admittedly small. The fund selectively bought into the run-up when individual P/Es were in single digits, but backed off once they hit the high teens.
BUT EVEN WHILE STOCKS are approaching more palatable valuations, earnings forecasts remain weak as Beijing rolls out stimulus measures, including interest-rate cuts and easier bank-capital rules aimed at bolstering growth. Earnings estimates vary widely, with CLSA’s Cheung expecting earnings-per-share growth of 6% to 7%, while Bernstein’s Parker has a bullish forecast of 16% to 17%.

“Earnings revisions have all turned fairly negative, particularly for those areas of the market sensitive to the economy,” Swan says. PetroChina (601857.China), which has the index’s heftiest weighting, is forecast to see EPS plummet 50%. ICBC, Agricultural Bank of China, and Bank of China will see flat profit growth or edge negative.
For investors eager for China stocks, the usual lessons apply: Look for strong fundamentals or, as BlackRock’s Swan says, all-weather companies. And Hong Kong’s H shares tend to be better-quality names and look cheap compared with Shanghai. For a few picks from that market, “3 Cheap Hong Kong Blue Chips. 

DANIEL SHANE is a staff writer at Barron’s Asia.