Commodities supercycle still with us and stronger than ever

In 2007, she claimed the current commodities super-cycle would last another 20 years. But given the economic implosion since that time, could it still be true? "Absolutely," says Carmel Daniele, founder, CEO and CIO of CD Capital. Interview with The Gold Report.

Author: The Gold Report
Posted: Wednesday , 19 Aug 2009

VANCOUVER, BC -

"The crisis that occurred last year after Lehman's collapse just interrupted the cycle," explains Carmel Daniele, adding that it "is actually going to seal the next stage of the super-cycle. . .it will make it stronger and last even longer." Significant supply shortages resulting from both the current lack of money flowing into exploration and planned infrastructure spend by emerging countries will continue.

The Gold Report: Carmel, in 2006 you started your fund, the CD Private Equity Natural Resources Fund, specifically to take advantage of the commodity super-cycle. In 2007, you stated you thought this super-cycle could last at least another 20 years. Since 2007, several key commodities are trading at substantially higher levels-even with the market adjustment of 2008. Have the market fluctuations since 2007 affirmed or challenged your view that this commodity super-cycle has another two decades to run?

Carmel Daniele: Absolutely affirmed it! The crisis that occurred last year after Lehman's collapse just interrupted the cycle, and I believe the cycle is still alive and well. And I also believe that what's happening with this crisis is actually going to seal the next stage of the super-cycle, and it will make it stronger and last even longer. This financial crisis may have dampened demand, but it has actually destroyed supply because a lot of mines have shutdown and cut off supply. And you will see when demand picks up-and it doesn't take very much for demand to pick up-there will be no supply because you can't just flick a switch on and off to turn on supply. It will take a lot of time to crank up the mines and get them supplying again to meet that demand for raw materials.

It takes on average about 7 to 10 years to get a mine into production after there's been a discovery of a mineral, and when you look at the super-cycles of the last eight years, I can't think of any major new supply or a new mine coming on stream except maybe Fortescue Metals Group (ASX:FMG), but that's exceptional. So, once demand starts picking up, the supply and demand imbalance will be a lot bigger and we will gear up again in the cycle.

Also if you look at history, on average, the past cycles have lasted an average of about 20 or 30 years. In the 1880s, the U.S. industrialization super-cycle lasted 40 years, and that involved the industrialization and urbanization of only 100 million people. In the 1960s, after World War II the Japanese industrialization super-cycle lasted 20 years-and that involved 30 million people. And the one we have now with China and India, which is only nine years in, involves the urbanization and industrialization of 3 billion people. So, I wouldn't be surprised if it lasted longer than 20 years.

But historically, these super-cycles have a lot of violent swings up and down, but the trend is up. So, you have to be a long-term investor in order to be able to survive the dips. They also provide a lot of opportunities when there are dips.

TGR: In the industrializations you pointed out in the U.S. and Japan, and now China/India, are all commodities going to rise universally or will some rise before others?

CD: No, they don't always rise at the same time. It all depends on what is driving it at the time; for example, it may be energy and coal demand for infrastructure spending. It all depends on the demand and supply balance of the particular commodity; and they go through different cycles. So, they won't all happen at the same time. It just depends on which country is demanding what and where the supply is coming from. Also I think what you will find over time is some countries will build barriers around a strategic resource, and we're starting to see that already, where some countries are starting to put duties on exports so they can consume the raw materials themselves and secure their own supply.

TGR: There's been a lot of press related to China, not so much about barriers, but the fact that they're starting to stockpile base metals and raw commodities. What's your feeling in terms of China and the influence they will have with potential barriers and duties on commodities, and what will that mean to the commodity prices?

CD: That's a very interesting question. Basically, they have a list of strategic resources and it's actually illegal for foreigners to own certain metals. You've got to actually watch and see what China is doing rather than listening to what they're saying. What they've been doing is taking advantage of the low copper prices and stockpiling. Iron ore is one that is really interesting when it comes to China, because they actually import almost all of the iron ore that they need. They don't have very high-grade iron ore in China and they've been trying to control the price as the world's largest importer at 60%.

The government of China sees iron ore as a very much-needed resource for their infrastructure that they're going to be building. I think they're going to be spending over half a billion U.S. dollars on roads, railways and power. They've been trying to take control of the pricing, through the China Iron Ore and Steel Association, as they can't do that with 100 steel mills all negotiating their own price. So, they've threatened to reduce the number of import licenses of iron ore to under 10 so the government can get better control over the pricing. All this has collapsed the annual negotiations over iron ore pricing.

The other one is rare earths; they have a monopoly on rare earths. China ranks number one in total reserves, production and exports in the world. There's another mine in Greenland, Greenland Minerals Ltd. (ASX:GGG), for example, that's got the potential to be bigger than China's, which would threaten the monopoly that China has over rare earth prices.

It is interesting because when it comes to foreign ownership of China's metals, it's very difficult; yet, they're trying very hard to control iron ore and other metals around the world that they don't have internally. And India, I believe, has threatened to further increase export taxes on the export of its iron ore because it's very strategic to its own industrialization and building of infrastructure.

So, you see the world has got limited resources; you've got all these emerging countries growing at a phenomenal rate. You've got this population explosion, and they're all waking up to the fact that maybe they're not going to have enough resource to continue building out their empires.

TGR: As the demand from India, China, and other developing countries increases, what investment opportunities do you see?

CD: There are two drivers. First, the population explosion-the world's growing by more than 17 million people per year. In 2008, the world population was 6.5 billion with 3 billion in cities; by 2030, there will be over 8 billion people on the earth, and 5 billion will be in cities. So, there will be an extra 2 billion people living in cities, needing things like housing, cars, and of course to be fed. Because of that, I like potash and phosphate, which goes into fertilizer, which is used for agriculture to feed the growing population.

The other big driver is all the emerging countries' infrastructure spending. In the next five years, Asia, excluding Japan, will spend over $2.5 trillion in infrastructure and that's going to need a phenomenal amount of iron ore and coal.

TGR: You mentioned copper, and copper is often held up as the precursor to any economic boom.

CD: Yes, I love copper; I'm a copper bull. Copper goes into infrastructure spending and there are not many substitutes for copper. There haven't been very many big discoveries of copper mines and it will take some time for supply of the large mines to come on stream. A lot of the large ones are in politically challenged jurisdictions like the DRC and Alaska, which has lots of environmental hurdles.

TGR: Do you see the possibility that the limitation of these natural resources will limit the ability for these countries to expand?

CD: Yes, that is why China is strategically building up its resources; it's very shrewd. I think that China is positioning itself perfectly; it's the iron ore and a few other minerals that they're actively looking for. Yes, I think it could probably slow down if they don't have the metals they need. Or they could start using substitutes.

TGR: But in the situation like lithium or copper, there really aren't any substitutes; so could that limit the expansion we're going to see here in the next five years?

CD: Given that there's no money flowing for the exploration for these metals, it has a double whammy effect. Yes, I'd say in the next five years, probably, you'll start seeing a chronic shortage of some of these metals, if there's no substitute. But really, you can't go on a plane with a laptop and have fuel in your computer so there are few viable substitutes for lithium. And lithium is related to electric cars, as well. The people in China are going to start buying more and more cars, because there are tax subsidies in China for people to buy cars and apparently only 5 out of a 100 people in China own a car today. Imagine when they get to the U.S. ratio of 70 out of 100 how much metal those new cars will consume.

TGR: So, with these shortages, how are you positioning your Fund to take advantage of those investment opportunities?

CD: Well, basically, what I'm trying to do is invest in anything that these emerging countries need to continue their industrial revolution, and remember, they are the ones with the deep pockets. So, what I look for is investing in companies that have a world-class resource that is attractive to the emerging markets either through an off-take or through actually buying it outright.

And the interesting thing is this crisis is different than other crises we've seen because the emerging markets are the ones with excess foreign exchange reserves. China has $2 trillion U.S. dollars in foreign exchange reserves. India's got a quarter of a trillion. Russia's got half a trillion. So, they've got the deep pockets. And they're actively looking to convert their U.S. dollars into hard assets. And it's not just these three emerging countries that I've mentioned that have surplus cash; there's Korea and Japan, as well.

TGR: What are some of the investment plays that you're doing right now with the Fund?

CD: I invest predominantly in private companies because I am trying to look for tomorrow's stories today at low prices. One interesting private one is a high-grade iron ore company with 4.5 billion tons in Brazil; it's the third-largest in Brazil. It's the lowest quartile of producers, and it's the best positioned to consolidate iron ore producers in Brazil. China is also now increasing its imports of iron ore from Brazil and has reduced its imports slightly from Australia. If you look at the shipping that's going from Australia and Brazil to China with iron ore compared to previously, you will see a big jump from Brazil, and I think it's because China's a little bit disappointed that they missed out on the Rio Tinto (NYSE:RTP) acquisition.

Other private companies are coal in Canada, and coal in Indonesia. As I mentioned, India is hungry for thermal coal, especially from Indonesia because it lowers transport costs and light sulfur coal suitable for their existing and new coal-fired power stations. So, if you're bullish on iron ore, you've got to be bullish on coal as well. And Canada's got lots of untapped resources and high-grade met coal and a long market history in the Asian steel industry. There's a lot of infrastructure already in place there to deliver to export markets.

Another one that I am looking at is potash in Brazil. It's amazing, but Brazil imports 90% of its potash needs, and it's got a growing agricultural market. So that's only just growing. I am just amazed that Brazil got itself into this position.

TGR: You're mentioning a lot of private companies. How can our readers who are individual investors take advantage of some of these tomorrow stories today?

CD: The best way to take advantage of these private companies is to invest in a Fund like the CD Private Equity Natural Resources Fund that invests predominantly in privates.

I'm a big believer in people; I am a backer of jockeys, rather than horses, and so I think the key is to look for a really good management team and you just have to look at what the market will pay for top management. One example is my ex-colleagues, Pierre Lassonde and David Harquail, at Franco Nevada Corp. (FNV.TO), who in their last fundraising managed to raise money at a premium to the market price. That's a good one as they have an excellent business model. It's a royalty company and they don't have to lie awake at night worrying about day-to-day mining technical issues. They just have to cash their royalty checks.

Columbia Goldfields Ltd. (TSX:GOL) (OTCBB:CGDF) is another one I like. It has recently been subject to a takeover by Medoro Resources Ltd. (TSX.V:MRS). Colombia Goldfields is completely undervalued; it has five million ounces of gold. What I like about the merger is that it is a perfect match of a great asset with management that has a really good track record in the region. There will probably be further consolidation in that region as the management knows the region very well.

Another one is Petaquilla Minerals Ltd. (TSX:PTQ) (OTCBB:PTQMF) (FSE:P7Z). I have in the past backed the management team there when they spun out Petaquilla Copper. Now, they're doing another spin out. If you invested in Petaquilla Minerals, which has gold in Panama, at some stage you'll get one share in Petaquilla Infrastructure for every four shares you have in Petaquilla Minerals. You will be able to benefit from each project. Petaquilla Minerals will receive cheaper power, cheaper mining costs and less dilution, while Petaquilla Infrastructure will benefit from guaranteed power off-take with exposure to the growing power demands in Panama and surrounding countries.

Another one I like is Greenland Minerals and Energy (mentioned previously); it has a very large rare earth deposit in Greenland. It's the largest outside of China; potentially it could be the largest in the world because there is still potential upside in their resource. The other thing-and not many people know this-is that they have over 200 million pounds of uranium as a by-product.

TGR: Wow!

CD: Yes, and this company could be a threat to the monopoly that China holds over supply, and this could help attract interest from Japanese and North Korean groups to secure their own supply outside of China.

TGR: What's your view on the precious metals market?

CD: I think gold, for example, given the crisis, is something you have to have in your portfolio. I mentioned Colombia Goldfields, which has 5 million ounces of gold. Another one that I like is New Gold Inc. (TSX:NGD) (NYSE.A:NGD), which Pierre Lassonde is behind; they did a three-way merger. They've recently acquired Western Goldfields Inc. I mentioned Petaquilla Minerals as well, which is another gold company with gold in Panama.

I also like Norseman Gold PLC. (ASX:NGX) (LN:NGL), listed in both London and Australia. It is producing and generating significant surplus cash flows from the high Australian gold price. It also has the working capital needed to fund the expansion of its underground mine and increase production at its under-utilized plant.

Gold is a psychological metal; it does well basically when everything else isn't doing well. That's why you need to have some in your portfolio. I don't have my whole portfolio in it; I just have a small interest in precious metals. And we're also looking at some projects with platinum and palladium only because they're used in motor vehicles and China's going to increase the number of cars, so I am still very bullish on these as well.

TGR: Do you have any specific companies you're looking at for platinum or palladium?

CD: There's one that's called Nkwe Platinum Ltd. (ASX:NKP). They have a portfolio of platinum deposits located in one of the largest and richest platinum regions in the world. They expect upgrades to their already-large resources, as well as the completion of the feasibility study by late this year.

TGR: Are you also following Colossus Minerals Inc. (TSX:CSI) ?

CD: Yes, we are. We've invested in a private gold company, Latin American Gold, which we think that will be the next Colossus Minerals.

TGR: Carmel, any last thoughts you would like to give to our readers?

CD: I think we are very lucky to be experiencing what's happening with the whole commodities super-cycle. The stars are all aligned, and it's just very exciting. It's going to last a very long time, and this is something you see only once in every couple of generations. What we're witnessing now is something that will be written up in history books some day, with the emergence of China as a super-power and India close behind. And I think that this crisis, though some people see it as a negative, is fantastic because basically there are so many opportunities around that you could buy at distressed prices, and you can throw valuations out the window. For a long-term investor, if you buy now, you can make great fortunes when the super-cycle comes back again, and it will come back, longer and stronger.

Carmel Daniele is the founder of CD Capital and CIO of the CD Private Equity Natural Resources Fund. The Fund's investment objective is to achieve capital growth through pre-IPO and pre-trade sale companies in the natural resources sector, targeting opportunities that deliver substantial returns on exit.

Carmel was previously focused on selecting and negotiating natural resource investments for the Special Situations Fund at RAB Capital. Prior to this she was a Group Executive in Corporate Advisory at Newmont Mining, negotiating and structuring mergers and acquisitions around the world for the Newmont Capital group which included the US$24 billion three-way merger between Franco-Nevada, Newmont and Normandy to create the largest gold company in the world.

Published courtesy of The Gold Report - www.theaureport.com

Is China sneezing?

Is a bubble bursting in China's stock markets, or have this month's events been more about healthy profit taking?

Author: Barry Sergeant
Posted: Thursday , 20 Aug 2009

JOHANNESBURG -

Stock markets in China touched 12-month highs during the first few days of this month, and have since declined sharply, by close to 20% in some cases, creating, for some investors at least, the notion that an apparent chill may gain momentum in the country ranked for years as the epicenter of global economic growth.

In Western markets there has long been a loose rule of thumb that when markets correct by 20% or more, a bear trend is underway. Stock market levels in China, as measured by MSCI Barra, reached multi year highs in 1997, and waited a full decade to reach similar levels, as seen in October 2007. Stocks then declined on average by more than 70%, to October 2008, and then doubled before blowing off earlier this month. The levels seen earlier this month were about half the highs seen in 1997 or 2007.

But this may not allay some fears that Chinese stock markets have popped a bubble and are about to collapse. This month's sell off has been inspired mainly by a growing belief that China's monetary authorities may become somewhat hawkish, after the country's monetary base was allowed to expand by around US$1 trillion so far this year. This may, however, have been enough to create necessary upside momentum.

Seen over the longer term, China's economy has managed to post double digit annual growth for more than 30 consecutive years. For the bulls, the so-called global financial crisis, where the biggest single nuke was unquestionably the 15 September 2008 collapse of erstwhile Wall Street investment bank Lehman Bros., did little to derail China's growth record of three decades.

Chinese exports have been affected, to be sure; the country's economic growth was a relatively modest 6.1% in the first quarter of this year, but expanded to 7.9% in the second quarter. A gigantic stimulus spending package, inspired by global financial crisis, real or otherwise, was allied in China by interest rate cuts and, once again, careful driving from the centre. China's burgeoning middle class is increasingly adding a flip-side dimension to the once export-heavy economy; so far this year, industrial output has increased by 10.8%, and retail sales have expanded by 15.2%. The Goldman Sachs Group anticipates that the country's annual economic growth for 2009 could come in at 10%, a number revised upwards from 9.4%. The double digit growth record over three decades may yet survive intact.

All told, the recent sell off in Chinese stocks can be seen, for now at least, as a healthy round of profit taking. The CSI 300, a broad index measuring the performance of 300 China-listed stocks, is still 96% above its 12-month lows; the narrower Shanghai Composite is 75% above its lows. While the net performance of these indices ranks up there with the best, overall, in the world, there is little in the background to suggest that bubbles are bursting in China's stockmarkets.

From a valuations viewpoint, there is little question that stock valuations had become somewhat overcooked of late. Mining stocks, which can be most readily compared with peer-type stocks outside China, had overreached the valuation metrics derived from mining stocks elsewhere. Recent bouts of profit taking have restored a degree of neutrality to comparative valuations.

Swiss Banks Court New Markets, Shun Americans as Secrecy Erodes

Swiss Banks Court New Markets, Shun Americans as Secrecy Erodes

Share | Email | Print | A A A

By Warren Giles and Dylan Griffiths

Aug. 20 (Bloomberg) -- Swiss private bankers are turning to emerging markets and shunning American clients as the government’s agreement to hand over the details of 4,450 UBS AG accounts to U.S. authorities erodes bank secrecy.

Yesterday’s settlement in a lawsuit against UBS comes five months after Switzerland said it would renegotiate tax treaties to avoid being blacklisted as anuncooperative tax haven. Swiss banks hold $2 trillion for individuals overseas, or 27 percent of the globe’s offshore wealth, according to Boston Consulting Group and the Swiss Bankers Association.

“It shows Swiss banks can be put under pressure by foreign tax authorities,” said Teodoro Cocca, professor of wealth management at Johannes Kepler University in Linz, Austria. “Bringing new money to Switzerland will be considered risky.”

Some of Switzerland’s 300 banks are already shifting their focus to Asia, Russia and the Middle East, stressing their financial expertise and Switzerland’s reputation for stability and security. Julius Baer Holding AG, Lombard Odier & Cie. and Bank Sarasin & Cie. have opened offices from Moscow to Singapore and Mumbai in the past two years.

The decline of bank secrecy has been an issue for Swiss bankers since 2002, when the European Union asked for the automatic exchange of tax information, said Alfred Mettler, an adviser to the Swiss government on banking secrecy and a professor at the Robinson College of Business at Georgia State University in Atlanta.

“Bank secrecy will change and over time there will be less and less untaxed money in Switzerland, especially from the U.S.,” Mettler said. “But privacy will remain important, even with double-taxation agreements.”

‘Scheme to Defraud’

The U.S. Internal Revenue Service plans to target other financial institutions, law firms and entities that help Americans hide assets offshore, IRS Commissioner Douglas Shulman said yesterday in an interview with Bloomberg Television.

UBS admitted in February to participating “in a scheme to defraud the U.S.” The Zurich-based bank agreed to pay $780 million and disclose the names of more than 250 clients who allegedly hid assets from the IRS. A day later, the IRS sued UBS for information on as many as 52,000 clients, triggering the negotiations that led to yesterday’s settlement.

“Swiss bank secrecy that includes tax evasion is on its last legs,” said tax attorney Josh Ungerman of Meadows, Collier, Reed, Cousins & Blau LLP in Dallas. “The IRS made clear that U.S. clients at other Swiss banks are subject to U.S. requests for information if they engaged in the same type of tax evasion as UBS clients.”

Client Exodus

The litigation has already damaged UBS, adding to an exodus of clients hurt by the global financial crisis. UBS customers withdrew 156.3 billion francs ($146.8 billion) of assets over the past five quarters, dropping the bank into second place globally as a money manager for the rich.

“This agreement helps resolve one of UBS’s most pressing issues,” ChairmanKaspar Villiger said yesterday in a statement. “I am confident that the agreement will allow the bank to continue moving forward to rebuild its reputation through solid performance and client service.”

The Swiss tradition of bank secrecy dates to the 19th century. The first laws forbidding bankers from disclosing information were enacted in 1934, a year after Adolf Hitler passed legislation threatening to imprison Germans who didn’t declare money held abroad.

“This agreement doesn’t undermine Swiss bank secrecy,” said Michael Ambuehl, Switzerland’s chief negotiator on the UBS settlement. “I don’t think that there will be pressure on other Swiss banks on the basis of the UBS agreement. The agreement has been made specifically for the UBS case.”

Swiss Laws

The settlement complies with existing Swiss laws under which tax fraud, or actively misleading authorities, is a crime and tax evasion, or failing to declare assets, is not. It also gives clients the right to appeal to a Swiss court if UBS decides to turn over their names.

The government has said the new tax treaties it is negotiating will allow it to cooperate on both fraud and evasion cases if foreign authorities provide specific evidence of a violation.

The UBS agreement shows the limits of banking secrecy, said Martin Maurer, secretary general of the Zurich-based Association of Foreign Banks in Switzerland, which represents more than 140 institutions.

“If a bank undermines a foreign law, then you can’t expect the Swiss government to cover its wrongdoings in another country,” Maurer said.

American Accounts Closed

Increased scrutiny from U.S. regulators has led some Swiss banks to close investment accounts held by Americans.

UBS told U.S. clients in a March 27 letter that it planned to terminate their existing accounts within 45 days. Customers who wanted to continue banking with UBS were asked to transfer their assets into an entity registered with the U.S. Securities and Exchange Commission, according to a copy of the seven-page letter seen by Bloomberg News.

Geneva-based Mirabaud & Cie. is closing the “few remaining” accounts held by U.S. taxpayers, a company spokesman said in June.

HSBC Holdings Plc’s Swiss private bank and Credit Suisse Group AG have also asked clients for permission to release their details to financial regulators in other countries that demand investor disclosure.

The Swiss unit of HSBC, Europe’s biggest bank, in September asked clients to surrender their right to secrecy if they wanted to hold securities in 28 markets. The bank said it “strongly recommends” that independent money managers renounce banking secrecy for clients who want to invest in the U.S., Germany, the U.K., Russia, Singapore and seven other markets.

Ringfencing Americans

“The big banks will probably ringfence American clients and concentrate on developing emerging markets, such as India and China,” said Matthew Ledvina, an international tax lawyer in Zurich. “It’s hard to beat countries like Switzerland for political risk.”

Some Swiss banks are also opening branches in new European markets to serve clients in their home countries, instead of in Switzerland.

Julius Baer opened offices in Istanbul, Moscow and Milan in the past two years. Lombard Odier, Geneva’s oldest private bank, has expanded in Prague and Singapore, and Bank Sarasin opened branches in Mumbai, Warsaw and Frankfurt.

Pictet & Cie., Switzerland’s biggest closely held private bank, is expanding its Frankfurt-based staff to attract more onshore money from German clients.

“Switzerland has to promote its political stability, the skills of its employees and its low-tax environment,” said Cedric Tille, a professor at the Graduate Institute in Geneva and a former economist at the Federal Reserve Bank of New York. “If all we have to offer is the ability to hide from the tax man, then we are in trouble because that would be building a financial model on sand.”

damaging drop of the dollar and slower global growth

Bernanke Diverging With King Means El-Erian Sees Dollar Decline

Share | Email | Print | A A A

By Rich Miller

Aug. 20 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and fellow central bankers gathering in Jackson Hole, Wyoming, are showing scant signs of reprising the coordinated stance they took fighting the worst financial crisis since the Great Depression as they deal with its aftermath.

The danger is that such a disjointed approach will lead to volatile financial markets, a damaging drop of the dollar and slower global growth, Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., said in an interview.

“The question is not whether the dollar will weaken over time, but how it will weaken,” said El-Erian, a former deputy director of the International Monetary Fund whose firm runs the world’s largest bond fund. “The real risk is that you will get a disorderly decline.”

By the end of 2010, the euro will rise to about $1.60, its highest since April 2008, while Canada’s currency will appreciate to C$1.01 per U.S. dollar, its strongest since July 2008, as the U.S. is slow to tighten credit, said Sophia Drossos, co-head for global foreign-exchange strategy at Morgan Stanley in New York.

The euro traded at $1.4234 at 6:00 p.m. in New York yesterday, while the Canadian dollar was at C$1.0952 per U.S. dollar.

Bernanke, 55, and other policy makers, who meet on Aug. 20-22, are already staking out differing positions as they gain traction in their battle against a crisis that has cost financial companies worldwide about $1.6 trillion in writedowns and losses. The U.S. economy is forecast to grow by more than an annualized 2 percent in the second half of 2009 compared with an average contraction of more than 4 percent in the last two quarters of 2008, according to a Bloomberg survey of economists.

Unprecedented Purchase

Bank of England Governor Mervyn King expanded an unprecedented bond-purchase program by 50 billion pounds ($82.7 billion) on Aug. 6 to 175 billion pounds, saying the recession was “deeper than previously thought.” Less than a week later, on Aug. 12, the Fed said it would slow its buying of $300 billion in Treasury securities and finish by the end of October as the economy levels off. On Aug. 5, Bank of Israel Governor Stanley Fischer ended government-bond purchases as the economy resumed growing in the second quarter after contracting during the previous six months.

“What you would hope to happen is much better coordination internationally,” El-Erian said. “What’s likely to happen, however, is that national interests are going to dominate.”

United Front

Such divergent approaches contrast with the united front central banks took in the wake of Lehman Brothers Holdings Inc.’s collapse last year, when the Fed, European Central Bank, Bank of England, Bank of Canada, Swiss National Bank and Sweden’s Riksbank all cut interest rates on Oct. 8. The Fed also set up a record 14 swap lines with foreign central banks to provide them with dollars to ease a global liquidity squeeze.

The banks were forced to cooperate by the severity of the global credit crunch, said Peter Hooper, chief economist for Deutsche Bank Securities in New York and a former Fed official.

As the crisis ebbs, the desire to act in concert is likely to fade, Hooper said. The IMF forecasts the global economy will expand 2.5 percent next year after shrinking 1.4 percent in 2009.

“The biggest risk of central banks going at their own pace is currency overshooting,” Jim O’Neill, head of global economic research at Goldman Sachs Group Inc., said in an interview from London.

Raise Rates

Morgan Stanley’s Drossos recommends buying the currencies of countries that are likely to be among the first to raise interest rates while selling those of nations that have used quantitative-type easing to pump liquidity into their financial systems. She puts Australia and Norway in the first group and the U.K. and the U.S. in the latter.

Traditionally, the Fed has given little weight to the value of the dollar is setting monetary policy, Hooper said. President Barack Obama, in contrast, is counting on increased exports to propel the economy, according to National Economic Council Director Lawrence Summers.

Stronger exports are a “foundation for sustainable expansion,” Summers said in a March 13 speech at the Brookings Institution in Washington. Such shipments made up 12.7 percent of U.S. gross domestic product last year.

Summers, 54, who is considered by economists as a candidate to replace Bernanke when the Fed chairman’s current term ends in January, raised the possibility that major central banks should pay more attention to exchange rates at the Jackson Hole symposium six years ago.

‘Provocative’ Summers

Then president of Harvard University in Cambridge, Massachusetts, Summers described his remarks as “provocative” and also asked whether monetary-policy makers should give greater weight to financial stability. He declined to elaborate, NEC spokesman Matthew Vogel said.

Even at current exchange rates, the U.S. current-account deficit in trade of goods and services will widen to a record of more than $850 billion in 2012 from about $400 billion this year, said John Williamson, senior fellow at the Washington- based Peterson Institute for International Economics.

An orderly fall of the dollar would be good for the world economy as it helps the U.S. continue to expand while consumers retrench, El-Erian said, declining to be more specific about currency levels. Such a drop would also help other countries including China wean themselves off their dependence on exports, promoting growth worldwide in the process, he said.

Inventory Rebuilding

While the U.S. economy is picking up, the recovery is being driven by inventory rebuilding and Obama’s record $787 billion fiscal stimulus, Olivier Blanchard, chief IMF economist, suggested in a paper released by the Washington-based lender on Aug. 18. Neither will last, he added.

That means exports “must increase” for a sustained U.S. recovery to take place, he said. To help achieve that, “some coordination across countries is likely to be as crucial during the next few years as it was during the most intense part of the crisis.”

Without that coordination, there’s a danger of a disorderly dollar fall that would destabilize financial markets and could derail the recovery, he said.

The dollar has lost 12 percent since March 5 against an index comprising the euro, yen and four other major currencies.

While 54 strategists surveyed by Bloomberg News forecast that the dollar will end the year little changed, on average, from current levels against the pound and euro, volatility is already hurting some U.S. companies.

Currency Fluctuations

Avon Products Inc., the world’s largest door-to-door cosmetics seller, partly blamed currency fluctuations for a drop in second quarter net income to $82.9 million, or 19 cents a share, from $235.6 million, or 55 cents, a year earlier.

“Foreign exchange continued to significantly pressure profits,” Andrea Jung, CEO of the New York-based company, said in a July 30 statement.

The Bank of Canada is already wrestling with what to do about gyrations in the currency market. Governor Mark Carney said July 23 that the stronger Canadian dollar was a major risk to economic growth. Finance Minister Jim Flaherty followed that up on August 4 by signaling that steps could be taken to dampen volatility in the currency.

The bank may extend its commitment to keep interest rates at a record low 0.25 percent beyond the middle of 2010 if a strong currency threatens to prolong the recession, said Derek Holt, economist at Scotia Capital in Toronto. The Canadian dollar has risen nearly 16 percent against its U.S. counterpart since March 9.

Expansionary Policy

Fischer at the Bank of Israel is also grappling with unwinding an expansionary monetary policy while trying to contain the rise of the nation’s currency, the shekel, which has gained about 3 percent against the dollar since June 30.

With Barclays Capital forecasting on Aug. 5 that the Israeli economy will grow by 2.9 percent in 2010 after a 0.9 percent contraction this year, the 65-year-old central-bank governor is beginning to rein in his expansionary policies.

Israel will be the first central bank to raise interest rates, perhaps moving as early as next month, said Koon Chow, an emerging-markets strategist at Barclays in London.

That might lead to a steeper-than-desired rise of the shekel, he said. That is why former IMF deputy managing director Fischer, who is giving the luncheon speech at Jackson Hole on Aug. 21, has established a policy for the bank to purchase foreign currencies in the event of “unusual movements” in the shekel.

Recession Relapse

Monetary-policy makers worldwide may stay in sync if forecasts of an economic recovery prove stillborn and central banks hold off on tightening credit. Economists surveyed by Bloomberg put one-in-five odds on the possibility the U.S. will relapse into a so-called double-dip recession in the next 12 months.

David Kotok, chairman of Vineland, New Jersey-based Cumberland Advisors Inc., sees a risk of increased instability in foreign-exchange markets once policy makers start to sop up the money they have pumped into the global financial system.

“If central bankers act without coordination, they may find their currencies hammered or upwardly valued as markets react strongly or viciously” to interest-rate differentials, said Kotok, whose firm manages more than $1.2 billion. “Foreign-currency volatility will quickly cause adjustment in interest rates in the government-bond markets of the world.”

Buffett Says Federal Debt Poses Risks to Economy

Buffett Says Federal Debt Poses Risks to Economy (Update1)

Share | Email | Print | A A A

By Shamim Adam

Aug. 19 (Bloomberg) -- The U.S. must address the massive amounts of “monetary medicine” that have been pumped into the financial system and now pose threats to the world’s largest economy and its currency, billionaireWarren Buffett said.

The “gusher of federal money” has rescued the financial system and the U.S. economy is now on a slow path to recovery, Buffett wrote in a New York Times commentary yesterday. While he applauds measures adopted by the Federal Reserve and officials from the Bush and Obama administrations, Buffett says the U.S. is fiscally in “uncharted territory.”

The government is trying to spark business and consumer spending through a $787 billion stimulus plan spanning tax cuts and infrastructure projects, while the Treasury and the Fed have spent billions more on separate programs to rescue financial institutions and resuscitate the banking system. The U.S. budget deficit is forecast to reach a record $1.841 trillion in the year that ends Sept. 30.

“Enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects,” Buffett, 78, said. “For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.”

The “greenback emissions” will swell the deficit to 13 percent of gross domestic product this fiscal year, while net debt will increase to 56 percent of GDP, Buffett said.

Record Deficit

The U.S. budget deficit reached a record for the first 10 months of the fiscal year and broke a monthly high for July. The excess of expenditure over revenue for July climbed to $180.7 billion compared with a $102.8 billion gap in July 2008 as the government spent more than in any month in U.S. history, the Treasury said Aug. 12.

Officials must still do “whatever it takes” to get the U.S. economy back on its growth momentum, Buffett wrote.

“Once recovery is gained, however, Congress must end the rise in the debt-to-GDP ratio and keep our growth in obligations in line with our growth in resources,” Buffett said. “With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

Dollar Index

Pacific Investment Management Co., which runs the world’s biggest bond fund, said in an Emerging Markets Watch report that the dollar will weaken as the swelling U.S. deficit erodes its status as a reserve currency. The Dollar Index, which tracks the greenback against a basket of currencies, has fallen 12 percent from this year’s high in March.

“Unchecked greenback emissions will certainly cause the purchasing power of currency to melt,” Buffett said. “The dollar’s destiny lies with Congress.”

Buffett is the chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc. Buffett built Berkshire into a $155 billion enterprise over four decades with dozens of acquisitions, buying companies that sell ice cream, lease private jets and operate power plants.

Berkshire has been buying securities issued by governments outside the U.S. The company held about $11.1 billion in foreign government bonds in its insurance units as of June 30, compared with $9.6 billion three months earlier, Berkshire said in a regulatory filing on Aug. 7.

The value of holdings in U.S. Treasuries and so-called government sponsored enterprises slipped 5.3 percent in the three months ended June 30 to about $2.5 billion.

Buffett: Congress Must Cut Spending

Buffett: Congress Must Cut Spending

Wednesday, August 19, 2009 8:15 AM Article Font Size

Buffett stressed that once recovery is gained, Congress must end the rise in the debt-to-GDP ratio and keep its growth in obligations in line with its growth in resources. (Alex Wong/Getty Images) WASHINGTON -- Billionaire investor Warren Buffett said the U.S. economy has avoided a meltdown and appears on a slow path to recovery, but Congress must now deal with enormous amounts of debt that threaten to erode U.S. purchasing power. In an opinion column published on Wednesday by the New York Times, Buffett wrote that he "resoundingly applauds" actions by the Federal Reserve and the Bush and Obama administrations to pump trillions of dollars into the financial system. But the "gusher of federal money" has run up a high level of debt that could fuel inflation, he said. "The United States economy is now out of the emergency room and appears to be on a slow path to recovery," Buffett wrote. "But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself." Buffett, who runs insurance and investment company Berkshire Hathaway Inc, likened the economic threat of "greenback emissions" to the environmental threat of greenhouse gas emissions, leaving the United States with a deficit of $1.8 trillion or 13 percent of gross domestic product this year. In July, the government posted a $180.68 billion monthly budget deficit, a record for July, marking only the third time in the past 30 years that the government ran a deficit for 11 months in a row. Buffett said a revived economy will not be able to generate enough revenues to bridge the gap between outlays and receipts, so changes in taxes and spending will be required. Politicians will not likely have the will to raise taxes or slow spending, so they may opt to quietly let inflation increase, a move that will "confiscate" wealth and allow the United States to evolve into a "banana republic economy", he said. "Our immediate problem is to get our country back on its feet and flourishing -- 'whatever it takes' still makes sense," Buffet said in the paper. But once recovery is gained, Congress must end the rise in the debt-to-GDP ratio and keep its growth in obligations in line with its growth in resources, he wrote. "Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar's destiny lies with Congress," he said. Last month, in a newspaper column of his own, Federal Reserve chairman Ben Bernanke, said the huge amounts of money the U.S. central bank has pumped into the economy will not undercut its ability to push borrowing costs higher when the time is ripe. Stressing that the weak U.S. economy will likely warrant exceptionally easy monetary policies for a long time to come, Bernanke outlined in a Wall Street Journal opinion article how the Fed could raise interest rates even with cash flooding the financial system. "At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road," Bernanke wrote. The outline of the Fed's "exit strategy" from the extraordinary monetary policy easing it has undertaken in the past two years to deal with the global financial crisis was the subject of testimony to Congress by Bernanke in his twice-a-year economic report on July 21. © 2009 Reuters. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters.