Inflation in emerging economies

An old enemy rears its head

Emerging economies risk repeating the same mistakes that the developed world made in the inflationary 1970s

EVEN as America's economy teeters on the brink of recession and many European economies are slowing, central bankers in rich countries fear rising inflation. Yet the risks they face are smaller than those in emerging economies, where inflation has risen far more over the past year to its highest for nine years. There are also an alarming number of similarities between developing economies today and developed economies in the early 1970s, when the Great Inflation took off. Are the young upstarts heading for trouble?

China's official rate of consumer-price inflation is at a 12-year high of 8.5%, up from 3% a year ago (see chart 1). Russia's has leapt from 8% to over 14%. Most Gulf oil producers also have double-digit rates. India's wholesale-price inflation rate (the Reserve Bank's preferred measure) is 7.8%, a four-year high. Indonesian inflation, already 9%, is likely to reach 12% next month, when the government is expected to raise the price of subsidised fuel by 25-30%.

Inflation in Latin America remains low relative to its ignominious past. Even so, Brazil's rate has risen to 5% from less than 3% early last year. Chile's has leapt from 2.5% to 8.3%. Most alarming are Venezuela, where the rate is 29.3%, and Argentina. Officially, Argentina's inflation rate is 8.9%, but few economists believe the numbers. Morgan Stanley estimates that the true figure is 23%, up from 14.3% last year.

Indeed, official figures understate inflationary pressures in many emerging economies. Widespread government subsidies and price controls are one reason, and price indices are often skewed by a lack of data or government cheating. China's true inflation rate may be higher because the consumer-price index does not properly cover private services. Delays in data collection in India can mean big revisions to inflation: the final number for early March was almost two percentage points higher than the original. The latest wholesale-price inflation rate might therefore be pushed up to 9-10%. If measured correctly, five of the ten biggest emerging economies could have inflation rates of 10% or more by mid-summer. Two-thirds of the world's population may then be struggling with double-digit inflation.

The recent jump has been caused mainly by surging oil and food prices. For example, in China food prices have risen by 22% in the past year, whereas non-food prices have gone up by only 1.8%. Governments have responded with more price controls and export bans. India's government has suspended futures trading in several commodities, which it blames (wrongly) for high prices. In the short run such measures may help to cap inflation and avoid social unrest, but in the long run they do more harm than good. Preventing prices from rising reduces the incentive for farmers to increase supply and for consumers to curb demand, prolonging the very imbalance that has stoked prices.

Some central banks, including those in Brazil, Indonesia and Russia, have nudged up interest rates this year. But they have not kept pace with inflation, so real rates have fallen and are now negative in most countries, with a few exceptions such as Brazil, Mexico and South Korea. Russia's main policy rate of 6.5% is almost eight percentage points below its inflation rate. China's real lending rate is minus 1%.

Many policymakers in emerging economies argue that serious monetary tightening is not warranted: higher inflation, they say, is due solely to spikes in food and energy prices, caused by temporary supply shocks and speculation. Higher interest rates cannot call forth more pigs or grain. They expect inflation to ease later this year as higher prices prompt an increase in supply (food prices have started to edge down over the past month) and as sharp rises in commodity prices drop out of year-on-year comparisons.

Yes, food inflation is likely to slow later this year; but that does not mean rising headline inflation can be ignored. The synchronised jump in global food prices suggests that there is more to the story than disruptions to supply. Prices are also rising partly because loose monetary conditions in emerging economies have boosted domestic demand. These economies have accounted for over 90% of the increase in global consumption of oil and metals since 2002 and for 80% of the rise in demand for grain. This partly reflects long-term structural forces, but it is also the product of a money-fuelled cyclical boom. Peter Morgan, of HSBC, says that the initial shock to food prices may have come from the supply side, but the strength of income and money growth helps to validate higher prices. Were monetary conditions tighter, rises in food prices might be offset by declines elsewhere, keeping inflation under control.

Another reason why central banks cannot ignore agflation is that it can quickly spill over into other prices. Food accounts for 30-40% of the consumer-price index in most emerging economies, compared with only 15% in the G7 economies (see chart 2). So food prices weigh more heavily on inflation expectations and hence wage demands than in the rich world. Tighter monetary policy would help anchor expectations and stop higher commodity prices spreading into the wider economy.

Analysis by Goldman Sachs, for 1990-2007, confirms that in emerging markets, higher food prices did seem to push up other prices. In most developed economies the link from food to non-food inflation was statistically insignificant. Besides the larger share of food, this has two causes: central banks' credibility is weaker in most emerging economies, so that inflation expectations are less firmly anchored; and real wages tend to be less flexible. Both increase the risk of a price-wage spiral.

Philip Poole, also of HSBC, says that many emerging economies have run out of spare capacity because investment has not kept pace with economic growth. Hence firms are more likely to pass on cost increases. In both Brazil and India capacity utilisation is at record rates. Brazil's unemployment rate is at its lowest for almost 20 years. China, though, may still have some slack, thanks to strong investment.

The second-round effects of rising food prices are already visible in most economies. Andrew Cates, of UBS, calculates that in both Asia and Latin America the core rate of inflation (ie, excluding food and energy) has risen by one percentage point in the past year, to 3.4% and 6.2% respectively; in eastern Europe it has risen by three points, to 7.4%, largely because Russia is overheating. (In contrast, average core inflation in rich economies has barely budged.) Inflationary expectations are rising and workers clamouring for pay increases. In a survey of inflation expectations in Argentina, the average reply for the next 12 months was 36%. Russian wages are rising at an annual rate of almost 30%.

Turning off the tap

Some countries look more prone to rising inflation than others. From an analysis of wages, inflation expectations, demand and capacity pressures, and monetary growth, Mr Cates infers that Argentina, Brazil, India, Russia and the Middle East oil exporters face the biggest risks in the months ahead. Pressures seem less great in China, Mexico, South Korea and Turkey.

Clearly, monetary policy needs to be tightened. Instead, it has in effect been loosened: real interest rates are generally lower than they were a year ago. Short-term interest rates are also unusually low relative to nominal GDP growth (a crude gauge of where rates should be), which implies that monetary policy is very loose (see chart 3). The broad money supply has grown by an average of 20% over the past year in emerging economies, almost three times the pace in the developed world (see chart 4). Russia's money supply has swelled by fully 42%.

Add all this up, and emerging economies bear strong similarities to rich countries in the 1970s, when the Great Inflation took off. A synchronised boom in the world economy has caused commodity prices to surge. Governments have responded with subsidies and wage and price controls. Official statistics understate price pressures. Economies are running at full pelt. Money-supply growth is soaring. Inflation expectations are not anchored and labour markets are fairly rigid, increasing the risk of a spiral in wages and prices.

According to conventional wisdom, the monetary-policy mistakes that caused the Great Inflation are much less likely today because central banks are independent of politicians. But unlike the Federal Reserve and the European Central Bank (ECB), many central banks in emerging economies (notably China, India and Russia) are not fully independent. In another echo of the 1970s, they often face intense political pressure to hold rates low to boost growth and jobs.

Emerging economies are also in danger of repeating the blunder of central bankers in the rich world in the 1970s: they focus on core inflation as a reason for holding interest rates below the headline inflation rate. But negative real interest rates then further boost demand, while rising inflation expectations trigger bigger pay claims. Unless central banks tighten their grip soon, inflationary expectations could surge.

Central banks' monetary independence is also severely constrained by governments' desire to hold down currencies at a time when international capital is highly mobile—a problem the developed world did not face three decades ago. When central banks intervene in the foreign-exchange market to prevent a currency appreciating, they have to print money to buy dollars, which boosts domestic liquidity. The Fed's recent interest-rate cuts have made it even harder for emerging economies to tighten policy. If they raise rates they attract bigger capital inflows, and the extra intervention required to hold down their currency fuels inflation further, defeating the rate rise.

The central banks of both China and India have raised banks' reserve requirements several times this year to try to mop up excess liquidity, but they have left interest rates unchanged. The recent slide in the rupee leaves the Reserve Bank of India with more room to raise rates, but it has been slow to act. Hong Kong and the Gulf states, which still peg their currencies tightly to the dollar, have even been forced to cut interest rates, although their buoyant economies need tighter policy.

You might suppose that a downturn in America would tend to slow the emerging economies, but they have continued to sprint. Although emerging economies may have decoupled from America, their monetary policies have not. As a result, a slowing United States could perversely prove inflationary for them. The more the Fed cuts, the stronger the growth in liquidity and domestic demand in the developing world. In turn, this means higher commodity prices, which further squeeze American incomes and spending, prompting the Fed to push interest rates even lower. One way to regain control of interest rates is to impose tougher temporary restrictions on capital inflows. For example, in March Brazil introduced a 1.5% tax on foreign investment in government bonds. However, most studies suggest that capital controls do not work well in the long term.

To many Western economists and policymakers the solution is simple: emerging economies should allow more flexibility in their exchange rates. This would permit them to raise interest rates, and a stronger currency would help to curb import prices. But the links between exchange rates and inflation are complicated. Stephen Jen, of Morgan Stanley, argues that revaluation could encourage investors to expect further appreciation, which would attract yet more inflows of hot money and so exacerbate inflation. This is the problem that China now faces.

The only way to stem speculative inflows is to revalue a currency by so much that investors do not expect a further rise. But how much is that? Take the yuan. Mr Jen reckons it is already near “fair value” against the dollar, judged by such things as relative productivity growth and the terms of trade. On the other hand, to eliminate China's current-account surplus, the yuan might need to rise by a staggering (and politically unacceptable) 100%.

Mohsin Khan, the IMF's director for the Middle East and Central Asia, made a similar argument last week for the Gulf states. They should not revalue or modify their exchange-rate regimes now, he said, although inflation is high and rising. Any move too small to alter investors' expectations could draw in more short-term capital and add to inflationary pressures.

With capital so mobile and America's monetary policy so loose, emerging economies have no easy fix for inflation. Interest rates clearly need to be raised by a lot, but a tidal wave of capital could either boost domestic liquidity or cause currencies to become overvalued. Brazil has allowed its currency to rise by more than 100% against the dollar over the past five years. This has helped to bring inflation down (though it is now rising again), but the real is now widely thought to be overvalued, pushing the current account back into deficit.

APThe only way is up

One solution is to tighten fiscal policy, which would reduce excess demand. Rapid growth in public spending is partly to blame for the excessive growth in Brazil's domestic demand. But fiscal tightening would be hard to justify in China, which already has a budget surplus. A larger surplus would boost domestic saving and hence the country's already large current-account surplus.

Either way, emerging economies need to accept that because their productivity growth is faster than the rich world's, their real exchange rates will have to rise over time. That must mean either a rise in the nominal exchange rate or higher inflation; they cannot escape both.

What does higher inflation in emerging economies mean for the rich world? Continued rapid growth in those economies means that the prices of food, energy and raw materials will remain high. In other words this is a permanent relative-price shock, not a temporary one. Yet this does not mean that commodity prices will keep rising at their current pace. Higher prices will encourage increased supply. And even if prices remain at today's levels, the 12-month rate of increase will decline, helping to ease global inflation.

There are also concerns, however, that after many years in which its exports have helped to hold down global prices, China is now exporting inflation in manufactured goods. Figures from America's Bureau of Labour Statistics show that after falling for several years, the prices of imports from China rose by 4.1% in the year to April, the largest 12-month increase since the series started in December 2004.

China's new export?

However, Jonathan Anderson, of UBS, reckons that the sudden spurt in the prices of Chinese goods is misleading. If you look instead at the dollar prices of Chinese re-exports from Hong Kong (a series with a much longer pedigree), mainland export prices have been rising by around 3% a year since 2004. And if export prices have picked up recently this is entirely because of the rise in the yuan against the dollar, not faster inflation in China.

In any case, the impact of China on global inflation depends on differences in price levels between countries, not on the rate of change in its export prices. China has helped to hold down inflation in developed economies because its goods are much cheaper and they are gaining market share, replacing more costly goods. This will remain true for many years. Competition from China also forces local producers to cut their prices and it curbs wage demands in rich countries. As China moves up the value chain it will pull down the prices of a wider range of products. In other words, China will continue to help hold down global prices—although possibly by less than in the past.

The biggest risk from rising inflation lies in emerging economies, not in the developed world. Because food has a much bigger weight in household spending, not only are those economies more prone to a surge in inflation now, but the social and political consequences would also be more severe. This week Jean-Claude Trichet, the ECB's president, warned central banks around the globe not to repeat the mistakes of the 1970s. Back then, emerging economies played a far smaller role in the world than they do now. To maintain their new-found strength, their policymakers need to keep a firm grip on inflation. The longer it is allowed to climb, the greater the danger to future economic growth.

Fed's Geithner Says World Economy Is Coping With U.S. Slowdown

May 26 (Bloomberg) -- Federal Reserve Bank of New York President Timothy Geithner said the world economy is coping with the U.S. slowdown.

``The world is much better positioned to deal with consequences of the slowdown in the United States,'' Geithner said at a news conference in Jerusalem today. ``It's looking, at least for now, very resilient to the broad pressures you see, particularly concentrated in the United States.''

The Federal Reserve has cut interest rates seven times since mid-September to fend off a recession amid a housing slump that's driven up credit costs worldwide. Geithner, with Fed Chairman Ben S. Bernanke, orchestrated the March rescue of Bear Stearns Cos. from bankruptcy and opened lending to Wall Street securities firms to prevent a financial-market meltdown.

Geithner defended the U.S. Fed's rate cuts, saying they were ``absolutely correct.''

``The U.S. is going through a necessary but difficult adjustment process,'' he said. ``The circumstances in each country are different and the policy responses are going to have to be different.''

In contrast to the Fed, the European Central Bank has held interest rates at a six-year high since June to fight inflation even as market turbulence threatens growth.

ECB President Jean-Claude Trichet, speaking at the same news conference as Geithner, said the market correction is ``ongoing.'' Trichet also reiterated the ``concern'' of the Group of Seven nations about ``sharp fluctuations in major currencies'' after the euro rose to a record against the dollar.

G-30 Meeting

Otherwise, Trichet and Geithner declined to address questions relating to monetary policy. They were attending an event in Jerusalem hosted by the Group of 30, a private group mainly of current and former central bankers.

The world economy is better able to cope oil shocks today than it was in the 1970s, said Jacob Frenkel, the G-30's chairman and vice chairman of American International Group. ``The lesson is that we need to make economies more flexible,'' Frenkel said.

Oil surged above $130 a barrel last week.

The rise in world commodity prices isn't a speculative ``bubble,'' said Tommaso Padoa-Schioppa, who was finance minister in Italy's previous government. ``The price movements are due to increasing pressure of demand and improved living standards in vast areas of the world,'' he said.

Geithner said the world's biggest central banks and financial regulators are making an ``impressive effort'' to build an ``early consensus'' about reducing the vulnerability of the world economy to financial crises. Still, regulators need to find a ``better balance'' between supervision and relying on market discipline, he said.

Dollar Trades Near One-Month Low; Housing Slump Cuts Confidence

May 26 (Bloomberg) -- The dollar traded near a one-month low against the euro on speculation U.S. reports tomorrow will show a slump in home prices deepened and consumers were the most pessimistic in at least 15 years.

The U.S. currency fell versus the New Zealand dollar and held near a 25-year low against the Australian dollar after oil and gold prices gained, improving the outlook for commodity exporters. Traders pared bets the Federal Reserve will raise interest rates this year, after it cut rates seven times since September while the European Central Bank left rates unchanged.

``The data could take the wind out of the dollar,'' driving it to about $1.59 per euro this week, said Carsten Fritsch, a currency strategist in Frankfurt at Commerzbank AG, Germany's second-biggest lender. ``If economic data continues to be soft, then the idea that the Fed's rate cutting is over looks premature.''

The dollar traded at $1.5771 against the euro at 10:09 a.m. in New York, compared with $1.5762 late on May 23 and a one- month low of $1.5814 on May 22. The dollar bought 103.43 yen from 103.38. The euro traded at 163.14 yen, from 162.95 yen.

The U.S. currency fell to 78.71 cents per New Zealand dollar, from 78.50. It slid to 96.08 cents per Australian dollar, from 95.92. Crude oil for July delivery rose 0.5 percent to $132.90 a barrel and gold climbed 0.2 percent, extending last week's 2.5 percent gain.

Rand, Yuan

South Africa's rand, the worst performer of the world's 16 most-traded currencies, fell for a second day against the dollar after India's biggest mobile phone company scrapped plans to buy Johannesburg's MTN Group Ltd. The currency slipped to 7.7052 per dollar, from 7.6810 last week.

The yuan climbed to the highest since a dollar link was abolished in 2005 on speculation that China will quicken gains to damp inflation. The currency rose to 6.9367 per dollar.

Currencies in Europe will benefit from record oil prices because of the region's energy efficiency, exports to oil- producing nations and vigilance against inflation, according to Barclays Capital.

The euro, the British pound, the Swiss franc, the Swedish krona and the Norwegian krone should perform ``relatively well'' as oil prices rise, wrote David Woo, global head of foreign exchange strategy in London at the bank, the third-biggest currency trader. The U.S. dollar ranks bottom in terms of potential performance as energy prices climb, it said.

Fed Outlook

A S&P/Case-Shiller report released tomorrow will show home prices in 20 U.S. metropolitan areas slid 14.2 percent in March from a year earlier, the most since the figures were first published in 2001, a Bloomberg News survey of economists showed. The Conference Board consumer confidence index fell to 60 in May, the lowest since August 1993, from 62.3 in April, a separate survey showed.

Futures on the Chicago Board of Trade showed a 23 percent likelihood the Fed will raise its target interest rate by a quarter point at its Sept. 16 meeting, down from almost 40 percent a month ago. The odds for a quarter-point decrease rose to 7.3 percent, from no chance a month ago.

``The dollar will keep sliding amid the slowing U.S. economy,'' said Michiyoshi Kato, a senior vice president of currency sales in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan's third-largest financial group. ``Weaker data will force the Federal Reserve to lower interest rates further.''

The dollar may move between 102.90 yen and 103.60 yen today, Kato forecast. Currency trading may be subdued because markets in the U.K. and the U.S. are closed for a public holiday today, he said.

Yield Advantage

The yield advantage of German two-year debt over U.S. bonds of a similar maturity was 1.77 percentage points today, near the highest since March 31.

The euro may be supported by speculation the 15 countries that share the currency are strong enough to withstand a slowdown in the U.S., allowing the ECB to keep interest rates on hold to fight inflation. ECB Vice President Lucas Papademos said policy makers are ``strongly committed'' to controlling inflation, the Ta Nea newspaper in Greece reported on the weekend.

Consumer prices in the euro region rose 3.5 percent in May, faster than the 3.3 percent gain in the previous month, according to a Bloomberg News survey. The statistics office will release the figure on May 30. Data one day earlier will probably show unemployment in Germany, Europe's largest economy, declined for the 28th month in May, according to a separate survey.

Changing Rate Forecasts

JPMorgan Chase & Co., the third-largest U.S. bank, doesn't expect the ECB to lower rates this year, according to a research note published last week. Royal Bank of Scotland Plc, the U.K.'s second-biggest bank, last week pushed back its forecast for a reduction in rates to the second quarter of next year.

Bank of America Corp., the second-largest U.S. bank, abandoned its prediction for a rate cut at the end of this year and now expects the ECB to raise borrowing costs at the middle of 2009, according to a May 23 research note.

``Economic data from Europe suggest there's a decreasing chance that the euro will fall,'' currency strategists led by Tohru Sasaki in Tokyo at JPMorgan & Chase wrote.

The euro may rise to $1.60 against the dollar this week, according to charts that traders use to predict price movements, said Hiroyuki Tanaka, an analyst at Mizuho Corporate Bank Ltd.

Traders may accelerate buying as the currency has held above so-called support at $1.5727, on the upper side of clouds on the so-called ichimoku chart, said Tanaka. The chart analyzes the midpoints of historic highs and lows and a cloud indicates a resistance zone where sell orders may be clustered.

Criteria Buys 20% of Slim's Inbursa to Grow in Mexico (Update3)

May 26 (Bloomberg) -- Criteria CaixaCorp, the investment company owned by Spain's biggest savings bank, agreed to buy 20 percent of Carlos Slim's Grupo Financiero Inbursa SA for 1.5 billion euros ($2.4 billion) to tap economic growth in Mexico.

Criteria will pay 38.5 pesos ($3.71) a share for the holding as it takes part in a bigger stock sale by Mexico City-based Inbursa, the Spanish company said today in a filing. That's a premium of 8.6 percent above the May 23 closing price.

The unit of Barcelona-based La Caixa, which holds stakes in businesses worth about 24 billion euros, is buying the stock in Inbursa to diversify in a major Spanish-speaking country as the bank faces the increasing chance of a recession at home. La Caixa joins Spain's Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA in investing in Mexico as more workers escape poverty and use financial services there.

``Getting into Mexico looks like a good option because it's a high-growth market and banking is an area that Criteria should focus on,'' said Alberto Espelosin, a strategist at Zaragoza, Spain-based Ibercaja Gestion.

The Inbursa stake will also become a vehicle for expansion in the Americas, Criteria said, without giving further details. The unit is seeking to invest in Asia and central and eastern Europe as well as in Spanish-speaking countries.

Criteria rose 9 cents, or 2.1 percent, to 4.33 euros in Madrid.

Billionaire Banker

The Mexican bank was set up in 1984 by Slim, the world's second-richest man after Warren Buffett, according to Forbes magazine. Inbursa has 6.7 million customers, 5,000 staff, more than $170 billion in assets in custody or under administration and it earned $497 million last year, Criteria said.

Inbursa Chief Executive Officer Marco Antonio Slim said in October the bank would maintain its ``aggressive'' pace of growth in 2008 after doubling its consumer-credit portfolio in 2007. Marco Antonio Slim, one of the billionaire's six children, last year introduce a new credit card that carries the brand of a Mexican natural-gas distribution company. He predicted the card would add about 100,000 clients in its first year.

The CEO also said in October that it had 6 billion pesos of consumer credit on its books, comprising 9 percent of total loans.

Criteria will be able to name two Inbursa board members under the deal while the Slim family ``will keep the majority of the capital and the management,'' the Spanish company said. The transaction, which will be financed with debt, is due to close before the end of the year.

The deal is ``beneficial for both sides and from Criteria's point of view it will constitute a fundamental pillar in its international expansion,'' Ricardo Fornesa, Criteria's chairman, said in a statement.

Criteria's Assets

Criteria's other recent investments include buying 5 percent of exchange operator Bolsas y Mercados Espanoles and increasing its holding in highway operator Abertis Infraestructuras SA.

The unit said in April that first-quarter net recurring profit rose 41 percent from a year ago as it earned more from dividends. La Caixa's first-quarter profit fell 19 percent as income from asset sales declined and loan defaults increased.

Mexico's economy will grow an average 2.8 percent in 2008 and 2009, according to analysts' surveys collated by Bloomberg. That compares with 2.2 percent in Spain, where the economy grew 0.3 percent in the first quarter, the slowest in almost 13 years.

Spain faces a 30 percent chance of a recession in the next two years as the global credit shortage exacerbates a real estate slump, a separate survey showed.

Banks are increasingly looking to expand in Mexico, where about half of the population of 105 million lives in poverty. BBVA, Spain's second-biggest bank, has boosted its Mexican client numbers by almost 60 percent since 2003 to 14.6 million.

Stocks Fall in Europe, Asia; Shares Advance in Latin America

May 26 (Bloomberg) -- Stocks fell in Europe and Asia, led by financial firms and carmakers, on concern more bank writedowns and rising raw-material costs will curb economic and profit growth. Takeovers buoyed shares in Latin America.

UBS AG, Europe's largest bank, slumped to the lowest since March after saying it may face more losses from holdings in both U.S. and global mortgage markets. Nissan Motor Co. declined as Merrill Lynch & Co. cut its recommendation on the automaker, citing a ``tough'' U.S. market. Bridgestone Corp., the world's largest tiremaker by sales, retreated after rubber futures rose to the highest in 28 years. Banco Nossa Caixa SA climbed after analysts said the bank may extend its rally from a proposed sale to Banco do Brasil SA.

The U.S. market was closed for a public holiday. The MSCI World Index fell to the lowest this month, losing 0.4 percent to 1,511.44 at 4:45 p.m. in London as all 10 industry groups decreased except utility shares. China's CSI 300 Index sank 3.2 percent to the lowest since April 23, while Brazil's Bovespa Index added 0.4 percent.

``High raw-material prices in general will continue to be a central issue for the stock markets, as they will have implications on margins and earnings,'' said Rolf Biland, Zurich-based chief investment officer at VZ Vermoegenszentrum, which has the equivalent of about $4.1 billion. ``UBS just made clear again that the sector's problems won't be solved in a day and that the drought will continue.''

Credit Losses

European stocks had their biggest weekly decline in more than two months last week, while U.S. shares lost the most in almost four months, as investors speculated banks faced deeper losses and record oil prices sparked concern higher fuel costs will cut profits at airlines and hurt consumer spending. The MSCI World has dropped 10 percent from a record in October as the world's largest financial firms posted $383 billion in credit losses and writedowns since the beginning of last year.

Europe's Dow Jones Stoxx 600 Index slipped 0.2 percent today. The U.K. market was closed for a holiday. The MSCI Asia Pacific Index lost 2.1 percent, its biggest retreat since April 14, while futures on the Standard & Poor's 500 Index rose 0.1 percent.

The MSCI Emerging Markets Index fell 1.2 percent, declining for a fifth straight day, the longest losing streak since February. The MSCI index of Latin American shares climbed 0.3 percent, snapping a four-day retreat.

UBS sank 5.8 percent to 28.2 francs. The Swiss bank seeking $15.6 billion from shareholders to replenish capital had losses on non-U.S. residential and commercial real-estate securities in 2007 and the first quarter of this year which ``could increase in the future,'' according to a prospectus for the rights offer.

Nissan, Porsche

Nissan Motor, Japan's third-largest carmaker, lost 2.7 percent to 875 yen. Merrill lowered its rating to ``neutral'' from ``buy.''

Porsche SE, the maker of the 911 sports car, led European automakers lower, sinking 1.2 percent to 117.99 euros.

Crude oil rose for a second day in New York as militants attacked facilities in Nigeria and OPEC's president ruled out an increase in supplies.

Bridgestone declined 5.6 percent to 1,736 yen. Michelin & Cie., the world's second-largest tiremaker, slipped 1.8 percent to 57.67 euros.

Rubber futures rose as much as 3.6 percent to 341.8 yen a kilogram ($3,309 a metric ton), the highest since April 1980, as record oil prices make synthetic rubber more expensive.

Gold gained for a second day as higher energy costs and the dollar's weakness against the euro boosted demand for a hedge against inflation. Silver also advanced.

Slowing Demand

Stora Enso Oyj dropped 2.6 percent to 7.93 euros. Europe's largest papermaker was added to Goldman Sachs Group Inc.'s ``conviction sell'' list. UPM-Kymmene Oyj slipped 2.3 percent to 12.55 euros as Goldman downgraded the papermaker's shares to ``sell'' from ``neutral.''

``We continue to expect paper and packaging demand to slow in Europe in 2008 and, without major capacity rationalization, pricing power to remain weak through to 2010,'' Goldman analysts including Eshan Toorabally in London wrote in a note to investors, dated May 23. ``This is compounded by rising input costs.''

Nossa Caixa, Brazil's largest regional lender in government hands, gained 1.7 percent to 36.90 reais. The company, which jumped 32 percent on May 23, may be worth as much as 55 reais a share as investors recognize the potential for revenue growth from a proposed sale to Banco do Brasil, Deutsche Bank AG analyst Mario Pierry wrote in a note to clients.

Inbursa

Grupo Financiero Inbursa SAB, the bank controlled by billionaire Carlos Slim, rose 5.7 percent to 37.49 pesos after Criteria CaixaCorp, the investment unit of Barcelona-based La Caixa, said it would buy a 20 percent stake.

Gaz de France SA climbed 2.1 percent to 41.79 euros after the French utility said it's in exclusive talks to sell a 50 percent stake in energy holding company Segebel to Electricite de France SA, Europe's biggest power generator. The sale of the stake was agreed by Gaz de France in order to obtain European Commission approval for its merger with Suez SA.

Suez increased 1.5 percent to 45.03 euros.

Separately, Eni SpA confirmed that it's in exclusive talks to buy Suez's majority stake in Belgian natural gas distributor Distrigaz SA.

A2A SpA, Italy's biggest municipal utility, advanced 1.1 percent to 2.54 euros. The company is close to reaching an agreement to buy Cofathec Coriance SAS from Suez, la Repubblica reported, without saying where it got the information.

France Telecom

France Telecom SA, Europe's third-largest phone company, led an advance by European telecommunications stocks, adding 1.6 percent to 20.42 euros.

``In light of the high inflationary tendencies, investors tend to switch into more defensive stocks including utilities and telecoms,'' said Christoph Berger, a Frankfurt-based fund manager at Cominvest Asset Management, which oversees about $100 billion. ``For utilities, consolidation also plays an important role at the moment.''

InBev NV declined 2 percent to 47.90 euros. The world's biggest brewer is weighing a merger with SABMiller Plc as a fall-back plan should its proposed $46 billion bid for Anheuser- Busch Cos. fail, the Financial Times reported, citing an unidentified person familiar with the situation.

Luiz Fernando Edmond, a director at InBev, said the brewer is on the acquisition hunt, the Observer reported, citing comments made by Fernando in an interview.

An InBev purchase of Anheuser-Busch would not create value for the Belgian company's shareholders in the first three years after the acquisition's completion, Marc Leemans, an analyst at Banque Degroof SA, wrote in a note to clients.

Sunday, May 25, 2008

Bush, Democrats Sell Fear Itself on U.S. Economy

Commentary by Amity Shlaes

April 16 (Bloomberg) -- ``Depressing'' is the adjective we're hearing a lot when it comes to the U.S. economy.

There are reports of how the University of Michigan's consumer-sentiment poll is lower than at any time in the past quarter century. Senator Barack Obama speaks of how, in some places, ``the jobs have been gone 25 years and nothing's replaced them.'' A recent Pew survey suggests that fewer Americans see their lives improving than at any point in almost half a century.

The gloom is so thick that it feels positively German. And that's just our domestic press. The Brits have long since decided that doom is around the American corner. Covering Bear Stearns Cos., a reporter from the Independent wrote, ``Wall Street traders said they had never experienced such fear.''

The suggestion behind such talk is that the current situation isn't merely depressing. It is that the slowdown is like the Great Depression of the 1930s. You almost expect Senators Obama and Hillary Clinton to repeat the lines from President Franklin Roosevelt's inaugural address of 75 years ago: ``The only thing we have to fear is fear itself.''

The analogy is absurd. This economy is to the Great Depression what an April drizzle is to Hurricane Katrina. So far, the Dow has declined about 12 percent from its record high of last fall. In the Depression, it dropped more than 80 percent. Unemployment is about 5 percent. In the Depression it was 25 percent.

Maybe 2 percent of mortgages are in trouble, and abandoned homes line some parts of Cleveland Heights. During the Depression, more than half of Cleveland was underwater. Today, one big bank has collapsed. In 1931, 1,400 banks collapsed.

Bear Rescue

Even a comparison with more recent periods is a stretch.

Today, everyone is concerned about the consequences of the Bear Stearns rescue. On the right, critics argue that the Federal Reserve's decision to make funds available to Bear created moral hazard on a scale that can bring down our markets. These critics forget that in 1984 Washington actually nationalized a big bank. That bank was the nation's seventh largest, Continental Illinois. Yet the Reagan Revolution didn't stall.

In the late 1970s and early 1980s, the Dow languished in the 800s for a period longer than it takes to collect a college degree. Unemployment in 1982 was close to 10 percent. Yet you didn't hear too much talk about the New Deal or FDR's speeches.

So why so dark this time?

One reason is that last year and the year before felt so bubbly. As John Lipsky, then of JPMorgan Chase & Co., said, the market was so confident that ``the only thing we have to fear is the lack of fear itself.''

Infinite Wisdom

Another reason for the current gloom is U.S. susceptibility to foreign wisdom. Americans tend to believe that if the Brits say something and it's reported on Drudgereport.com, it must be so. But the U.K. press derives some pleasure in seeing misfortune in America, and often hypes that misfortune.

Yet another problem is our addiction to Markets TV, which bears more similarity than any of us like to acknowledge to the Weather Channel. Lacking a truly dramatic winter to report, the anchors will yap about wind chill. Hear enough about wind chill, and eventually you begin to believe in it.

The most important reason for the current mood is demography. Our trouble isn't that we have it so bad. It is that we have had it so good. Anyone who graduated college after that early 1980s' snap hasn't seen the Dow do much but go up.

Happy Days

The share of those who experienced the economy of the bumpy 1970s is fading. Too few people recall what it was like when mortgage rates approached 20 percent. There are fewer grandparents around to bring back the 1930s for us. If you have never seen a Katrina -- if you don't even know someone who has seen one -- then every little windstorm looks ominous to you.

In this election year, both parties are using the slump as an argument to gain votes -- the Democrats are offering a New New Deal, and Republican President George W. Bush is offering New Deal Lite in his stimulus package.

By writing stimulus programs now, the federal government is wasting firepower it would need in a real bust -- such as when, say, unemployment hits the levels of the early 1980s. By expanding Fannie Mae or Freddie Mac now, a move politicians seem unable to resist, we are inviting institutionally caused stagnation like Japan's.

Talk enough about people losing their homes, and Washington will pass a law that ``encourages'' -- or forces -- banks to forgive principal on some mortgages. Banks will take the lesson and restrict credit later.

Can't Afford This

In other words, the Depression image is one the U.S. simply can't afford to luxuriate in. Doing so takes away time from devising policies that would really make the economy more competitive.

One such policy includes a cut in corporate taxes of the sort that Republican John McCain suggested this week in an economic speech. Another is passing trade agreements with countries such as Colombia. But anxiety and an affection for free trade are located in different parts of the human brain.

FDR's motto applies today, albeit in a fashion he never intended. The only thing we have to fear is fear itself.