The Markets Are Weak Because the Candidates Are Lousy
The good news is that an Obama victory is already priced in.
GEORGE NEWMAN
A lot has been said about the causes of the drastic drops -- and extreme volatility -- in stock prices and the impending recession. Blame has been heaped on low interest rates and dubious mortgage practices, and on the subsequent collapse of real-estate prices and the freeze in financial markets. But one other major factor has largely escaped attention.
To state the obvious: The valuation of an individual stock reflects the collective expectation of investors about a company's future profits, dividends and appreciation, and the same is true of the market as a whole. These profits, in turn, are greatly influenced by government policy on taxes, spending, subsidies, environmental and other regulations, labor laws, and the corporate legal climate. Investors have heard enough from both candidates in the last month or two to conclude that prospects for a flourishing, competitive, growing and reasonably free economy in a McCain administration are bad, and in an Obama administration far worse. (In fact, the market's bearish behavior over the last couple of months pretty closely tracks Barack Obama's gains.)
If you don't believe me, please answer a few questions:
- Have you thought of what a gradual doubling (and indexation) of the minimum wage, sailing through a veto-proof and filibuster-proof Congress, would do to inflation, unemployment and corporate profits? The market now has.
- Have you thought of how easily a Labor Department headed by a militant union boss would push through a "Transparency in Labor Relations" law that does away with secret ballots in strike votes, and what this would do to industrial peace? The market now has.
- Have you thought of how a Treasury Secretary George Soros would engineer the double taxation of the multinationals' world-wide profits, and what this would mean for investors (to say nothing of full-scale industrial flight from the U.S.)? The market now has.
- Have you thought of how an Attorney General Charles J. Ogletree would champion a trillion-dollar reparations-for-slavery project (whittled down, to be fair, to a mere $800-billion, over-10-years compromise), and what this would do to the economy? The market now has.
- Have you thought of what the virtual outlawing of arbitration -- exposing all industries to the fate of asbestos producers -- would do to corporate liability and legal bills? The market now has.
- Have you thought of how a Health and Human Services Secretary Hillary Clinton would fix drug prices (generously allowing 10% over the cost of raw materials), and what this would do to the financial health of the pharmaceutical industry (not to mention the nondiscovery of lifesaving drugs)? The market now has.
- Have you thought of a Secretary of the newly established Department of Equal Opportunity for Women mandating "comparable worth" pay practices for every company doing any business with government at any level -- where any residual gap between the average pay of men and women is an eo ipso violation? Have you thought about what this would do to administrative and legal costs, hiring practices, productivity and wage bills? The market now has.
- Have you thought of what confiscatory "windfall profits" taxes on oil companies would do to exploration, supply and prices? The market now has.
- Have you thought of how the nationalization of health insurance, the mandated coverage of ever more -- and more exotic -- risks, the forced reimbursement for excluded events, and the diminished freedom to match premium to risk would affect the insurance industry? The market now has.
- Have you thought of Energy Czar Al Gore's five million new green jobs -- high-paying, unionized and subsidized -- to replace, at five times the cost, what we are now producing without those five million workers, and what this will do to our productivity, deficit and competitiveness? The market now has.
I could go on, but you get the point. Nothing reveals Mr. Obama's visceral hostility to business more than the constant urging of our best and brightest to desert the productive private sector ("greed") and go into public service like politics or community organizing (i.e., organizing people to press government for more handouts). Who in his ideal world would bake our bread, make our shoes and computers, and pilot our airplanes is not clear.
And if you think all this comes from an ardent John McCain fan, you couldn't be more wrong. The Arizona Senator has made some terrible mistakes, one of them trying to out-demagogue Mr. Obama to the economic illiterates. This kind of pandering never works. Such populists and other economic illiterates will always go for the genuine article.
Mr. McCain should have asked some simple questions -- pertinent, educational and easily understood by ordinary voters. Such as:
- If the rise in the price of oil from $70 to $140 was due to "greed" (the all-purpose explanation of the other side for every economic problem), was the fall from $140 to $70 due to a sudden outbreak of altruism?
- If a bank is guilty both for rejecting a mortgage ("redlining") and for approving it ("greed" -- see above), how might a bank president keep his business out of trouble with the law?
- If the financial turmoil of the last year or so was caused by inadequate regulation, which party has controlled both Houses of Congress and all of its financial committees and subcommittees (where such regulation would originate) in the last two years?
- If we bemoan the sending of $750 billion a year to our enemies for imported oil, which party has prevented domestic drilling for decades that would have made us more self-sufficient?
- You were unhappy with Congress, and in 2006 you cast your lot with those who, like Mr. Obama now, promised "change." Are you happy with the changes that have taken place in the last two years?
None of these questions have been asked loudly or often enough, while the other message -- everything is bad, it's all Bush's fault, and McCain=Bush -- has sunk in. So given his own penchant for business bashing, a McCain win would merely count as damage control.
The market is forward looking. If it is unhappy with a president, it does not wait almost eight years before the numbers reflect it. If it really anticipated good times under Mr. Obama, the market would have gained 40% in anticipation of the transition. By losing that much, it seems to be saying the opposite.
The silver lining in all this is that the market has already "discounted" an Obama win, so if that happens you won't wake up on Nov. 5 to find your remaining savings down the drain. If the unexpected happens, you may be in for a pleasant surprise.
Commentary by Amity Shlaes
Oct. 29 (Bloomberg) -- There are six days left until the election, so maybe voters have six minutes to spend on what is still a big issue: the economy. Or, more specifically, Republican John McCain's economic plan.
Many voters, even the non-Bloomberg types, are spending their spare minutes staring at screens, trying to determine how much money General Motors Corp. is going to get from the government. Or trying to figure out when Russia and China are going to shut out the dollar and create the petro, the world's next reserve currency. Or trying to pinpoint on their 2010 calendar the date when recovery will finally come. McCain? Pronounce those two syllables at your peril.
For those willing to endure the derision, it is worthwhile to take one last good look at the McCain economic program. You will find a serious agenda. McCain deserves his six minutes. Allocating 60 seconds per component, we can review his plan and find much that would doubtless contribute to a recovery.
Minute One: Cutting the corporate tax by 10 percentage points, to 25 percent. A lower corporate tax rate would be a compelling reason for foreign money to want to stay here. It would help ensure that the dollar rally endures. It would drive the cash sitting around in what proved to be unprofitable investments -- subprime mortgages, for example -- into potentially profitable ones, many of which are as yet unidentified.
Capital Gains
Minute Two: Preserving the 15 percent tax rate on capital gains and dividends. McCain also has said he will make permanent President George W. Bush's income-tax cuts.
What today's financial crisis has revealed is that there are a lot of mediocre companies slumbering in portfolios. Many people are getting out of those companies now. More will want to make their exit in coming years, but the capital gains rate increase promised by Barack Obama and the Democrats might deter them. The result will be that cash will not flow as often to new companies that may be developing superior products.
McCain's rates would not only speed a recovery but also improve its quality and durability. In response to the crisis this month, McCain suggested cutting capital gains taxes in half in 2009 and 2010. It's not the ideal proposal, temporary as it is, but still McCain is heading in the right direction.
Capital Goods
Minute Three: Letting businesses expense technology and equipment in the same year they buy it. Under the current expensing provision, companies can write off half their equipment outlays in the first year and must depreciate other costs over a longer period.
Expensing 100 percent of equipment costs is a prospect that warms hearts in Cleveland, or Detroit, or any other place where machinery is a big part of business. Unfortunately, McCain is interested in restricting this break to three- and five-year asset classes. His reform would yield more dramatic results if it allowed all equipment to be expensed in the first year.
Minute Four: Building nuclear plants. This is the kind of infrastructure the U.S. really needs, and it would even be fine to use Treasury bonds to finance it. Less dependence on foreign oil means less instability in domestic markets. We also would spend less time riding the Vladimir Putin-Beijing rollercoaster.
Minute Five: Freezing government spending overall. A superb notion, even if most of us believe Washington isn't capable of passing it into law. After all, it takes more than Republican Senator Ted Stevens's conviction to restore sanity on spending in Washington. Here, McCain's temperament is a great advantage. We can imagine him saying ``No'' to new spending.
Getting Static
Minute Six: Taking the long view. McCain's advisers talk about dynamic -- not static -- analysis, looking at the growth and competitive environment generated by tax cuts. The Institute for Research on the Economics of Taxation finds that the McCain tax plan would add 0.5 percent to the annual growth rate for the private sector for five years. Obama's plan would subtract 0.7 percent a year in growth for the same period. As Steve Entin of IRET notes, politicians have hurt growth before by ignoring such effects.
The Obama vision is all static. It's better to redistribute, he says, because we sure aren't going to grow. This attitude ignores the possibility of expansion, and it's one that many lawmakers share, seeing only belt-tightening in the future. On some days, these gloomsters even include McCain.
Cost of Repeating
The philosopher George Santayana said that those who can't remember the past are condemned to repeat it. Entin puts a Washington twist on that line: ``Politicians who cannot remember the past condemn us all to repeat it.''
Sure, there are reasons not to consider McCain's plan as important.
One, as he has said, economics isn't his strength. So perhaps his plan may be merely theoretical, a construct that waits on the shelf while he pursues projects such as overhauling the military or cleaning up Congress.
Another, as John Tamny of realclearmarkets.com has pointed out, is a rising dollar. A stronger dollar functions as a tax decrease, meaning that any Obama tax increase may matter less.
Those of us with Santayana in our ears nonetheless do take McCain seriously. For McCain does remember a lot of the economic past. He is the candidate who can do the most to prevent us from repeating it.
Oct. 29 (Bloomberg) -- China cut interest rates for the third time in two months to stimulate growth in the world's fourth-largest economy after the global financial crisis curbed exports and production.
The key one-year lending rate will drop to 6.66 percent from 6.93 percent, the People's Bank of China said on its Web site today. The deposit rate will fall to 3.60 percent from 3.87 percent. The changes are effective tomorrow.
China's expansion dwindled to 9 percent in the third quarter from 11.9 percent in 2007 and industrial production grew at the slowest pace in six years in September as export markets dried up. The Federal Reserve may reduce its benchmark rate today and the European Central Bank has signaled that it's poised for a similar move.
``This cut was driven by the slowdown in the third quarter and the likelihood that the U.S. and other central banks will cut rates,'' said Xing Ziqiang, an economist at China International Capital Corp. in Beijing. ``It isn't likely to have an immediate impact on China's economy; what's needed is more government spending.''
Economic growth has slowed for five straight quarters. Signs of weakness span property, industrial production, export orders, and the 69 percent fall in the CSI 300 Index of stocks this year.
The rate cut ``shows that the government is pulling out all the stops to make sure that the gentle economic slowdown seen so far doesn't turn into something more serious,'' said Mark Williams, an economist at Capital Economics Ltd. in London.
Plunging Home Sales
Export orders dropped in the third quarter to the lowest level since 2005. Home sales plunged 55.5 percent in Beijing and 38.5 percent in Shanghai in the first eight months from a year earlier, according to the official Xinhua News Agency.
Sustaining growth is the government's ``first priority,'' Premier Wen Jiabao said Oct. 25.
The government has raised export-tax rebates, cut costs for home buyers and pledged infrastructure spending to protect jobs and stimulate growth.
A global slowdown is curbing demand for Chinese goods. The International Monetary Fund estimates that advanced economies will expand 0.5 percent next year, the slowest pace since 1982.
Lehman Brothers
China cut borrowing costs for the first time in six years on Sept. 15, the day U.S. investment bank Lehman Brothers Holdings Inc. filed for bankruptcy. It followed up with another reduction on Oct. 8 as the U.S. Federal Reserve and five other central banks made emergency coordinated reductions to counter the financial crisis.
Both cuts were accompanied by reductions in the proportion of money that banks must set aside as reserves. The central bank didn't reduce reserve requirements today.
The People's Bank of China has stalled gains by the yuan against the dollar since mid-July and eased annual quotas that limit lending by banks, to protect jobs and stimulate growth.
The central bank ratcheted up interest rates when the government was trying to stop the economy from overheating.
China shifted emphasis from fighting inflation to sustaining growth in July, when the Communist Party's top decision-making body, the Politburo, dropped any reference to a ``tight'' monetary policy. Consumer-price increases have slowed after reaching the fastest pace in 12 years in February.
``Beijing's shift to focusing on inadequate economic growth, rather than on excessive inflation, in July 2008 was the right call on their part,'' said Donald Straszheim, vice chairman of Roth Capital Partners, a U.S. investment bank specializing in emerging markets.
Capital controls, a world record $1.9 trillion of currency reserves, and a fiscal surplus will help to buffer China against the financial crisis. The nation's growth, the fastest of the world's 20 biggest economies, underpins demand for the exports of its Asian neighbors and commodities from iron ore to soybeans.
Oct. 29 (Bloomberg) -- The financial crisis exacerbated by credit derivatives is costing so much to fix that speculators are now using those same instruments to bet on governments as the price tag for bailing out banks approaches $3 trillion.
The cost to hedge against losses on $10 million of Treasuries is about $39,000 annually for 10 years, up from $1,000 in the first half of 2007, based on CMA Datavision prices. The equivalent for German bunds has risen to $37,000 from $2,000, while it has jumped to $66,000 from $3,000 for U.K. gilts.
Unlike John Irving's novel ``The World According to Garp,'' which provokes laughter from readers, the devastation amplified by derivatives is proving unfunny as taxpayers finance the financial system's rescue through measures such as the $700 billion Troubled Asset Relief Program, or TARP. Pressure is rising on policy makers to regulate a market that's moved beyond its origins protecting banks from loan losses to $55 trillion, prompting Warren Buffett to call the contracts a ``time bomb.''
``There's a huge gap in our regulatory system,'' former U.S. Securities & Exchange Commission Chairman Harvey Pitt said at an industry conference yesterday, referring to legislation almost a decade ago that excluded the derivatives from government oversight. The regulatory system is ``terribly broken,'' he said.
The Federal Reserve has given futures exchanges until Oct. 31 to present written plans on how they'll make the market more transparent, said four people familiar with the request. The Fed called banks and exchanges into three meetings in two weeks, pressing them to agree on a clearinghouse that would require dealers to post collateral and pay into a fund that would absorb losses if one of them were to fail.
Calls for Regulation
Turmoil triggered by credit-default swaps prompted calls from SEC Chairman Christopher Cox, Commodity Futures Trading Commissioner Bart Chilton and lawmakers including Senator Tom Harkin, a Democrat from Iowa, for Congress to authorize governing bodies to regulate the market.
New York Governor David Paterson said in a Sept. 22 statement that ``the absence of regulatory oversight is the principal cause of the Wall Street meltdown we are currently witnessing.'' New York officials proposed rules that would treat some of the contracts as insurance after the government was forced to bail out American International Group Inc.
`Absolutely Urgent'
``It's absolutely urgent that we bring disclosure to this corner of the market, that we let the market see where the risk is and price accordingly,'' the SEC's Cox told the House Committee on Oversight and Government Reform on Oct. 23.
Derivatives are contracts whose value is derived from assets including stocks, bonds, currencies and commodities, or from events such as the weather or changes in interest rates.
Credit-default swaps trade over-the-counter, leaving each party exposed to the risk the other won't fulfill the terms of the contract. The International Swaps and Derivatives Association, the industry group that has been setting the rules and acting as a self-regulator of the market, cited estimates that there were as much as $400 billion of contracts tied to Lehman Brothers Holdings Inc., even though the company only had $162.8 billion of debt, according to Bank of America Corp. analysts.
The Depository Trust & Clearing Corp., which runs a central registry for trades, placed the amount at about $72 billion.
The contracts, which aren't issued by the companies they are linked to, pay the holder the face value of the amount protected in exchange for the underlying securities if a borrower fails to adhere to debt agreements. A basis point on a credit-default swap contract protecting $10 million of sovereign debt from default for 10 years is equivalent to $1,000 a year.
AIG's $440 Billion
New York-based AIG amassed bets of more than $440 billion on U.S. home loans, corporate bonds and other assets by selling protection against default via the derivatives.
After ratings firms downgraded the insurer in September because of potential losses from the trades, AIG had to accept an $85 billion loan from the government and turn over majority control because of more than $10 billion in collateral it was required to post on the trades.
Lehman was one of the 10 biggest dealers in the credit- default swap market before it failed. New York-based Primus Guaranty Ltd. which managed $24.2 billion of credit-default swaps and sold guarantees on companies including Lehman and bankrupt Washington Mutual Inc. of Seattle, has tumbled 94 percent this year on the New York Stock Exchange to 40 cents a share.
CDX Index
Banks are now driving the cost of debt protection to new records as they seek to guard against losses on contracts bought from money-losing hedge funds. The Markit CDX North America Investment Grade Index, linked to the bonds of 125 companies in the U.S. and Canada, reached a record 240 basis points on Oct. 24, before falling back to 213 yesterday, according to Phoenix Partners Group. Europe's benchmark index reached a record 193 basis points before falling back to 163, according to JPMorgan Chase & Co. prices at 8:02 a.m. in London.
Buffett, called ``the world's greatest investor'' by biographer Robert Hagstrom, described derivatives in an annual report to shareholders of his Omaha, Nebraska-based Berkshire Hathaway Inc. as ``financial weapons of mass destruction.''
``The range of derivatives contracts is limited only by the imagination of man or sometimes, so it seems, madmen,'' Buffett said in the 2003 letter to shareholders.
Credit-default swaps are just a tool available to investors to hedge against losses, said Robert Pickel, head of the International Swaps and Derivatives Association in New York.
``To say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate and reflects an understandable confusion of the various financial products that have been developed in recent years,'' Pickel told a House committee on Oct. 14.
Competing Proposal
Four groups are vying to operate clearing operations, including a partnership between Chicago-based CME Group Inc. and Citadel Investment Group LLC and a team consisting of dealer- owned Clearing Corp., Atlanta-based Intercontinental Exchange Inc. and credit-default swap index owner Markit Group Ltd. Eurex AG, the world's biggest futures exchange, and NYSE Euronext have also submitted proposals.
The push to make the industry more transparent may finally let exchange-traded derivatives gain traction after years of failing to compete with banks. Eurex, the world's biggest futures exchange, opened the first market for exchange-traded credit derivatives in March 2007, beating Chicago Mercantile Holdings Inc. and Euronext, though dealers resisted moving to their platforms because it threatened their profits.
``The CDS market is going to go to exchanges,'' Emmanuel Roman, co-chief executive officer of GLG Partners Inc., which manages about $24 billion, said at the Hedge 2008 conference in London on Oct. 23. ``That's a very good development. Not good for the banks but good for everyone else.''
Downgrade Fears
Trading of credit-default swaps on government debt has increased since countries from the U.S. to Germany began pumping cash into their banks to prevent more failures, said Puneet Sharma, head of investment-grade credit strategy at Barclays Capital in London. The expenditures mean the ``probability of downgrade has increased,'' he said.
Investors are buying protection on countries to speculate on a deterioration of their credit quality and ratings as governments take on risky assets, even if they don't think there is a chance of default.
Gross issuance of Treasury coupon securities will rise to about $1.15 trillion in the 2009 fiscal year from $724 billion in fiscal 2008, according to Credit Suisse Securities USA LLC, one of the 17 primary dealers of U.S. government securities that are obligated to bid at the Treasury's auctions.
`Going Down'
``I do not think the U.S. market will blow up,'' said Pierre Naim, who bought default protection on Treasuries in January for his Rainbow Global High Yield hedge fund in the Bahamas. ``But the quality of U.S. government assets is going down by the day.''
Credit-default swaps on Treasuries have risen nearly 40 percent since TARP was signed into law October 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007, CMA Datavision prices show. Contracts on bunds soared by 77 percent and gilts by 66 percent over the same period.
The Treasury has allocated an initial $250 billion out of the $700 billion approved by Congress to shore up lenders, and is being pressured by the Financial Services Roundtable, a trade association of the 100 largest banks, securities firms and insurers, to broaden its guidelines so that insurance companies, broker-dealers, automobile companies and institutions controlled by foreign banks could also sell stakes to the government.
Oct. 29 (Bloomberg) -- Orders for U.S. durable goods, excluding cars and aircraft, fell for a second straight month in September as the credit freeze and a slump in sales caused businesses to cut back on investment.
The 1.1 percent drop in bookings of goods meant to last several years was less than forecast and followed a 4.1 percent decrease in August. A rebound in aircraft orders, a volatile category, and an increase in defense bookings unexpectedly pushed total orders up 0.8 percent.
The slump in manufacturing worsened in October as financing dried up, according to regional factory surveys. That suggests declines in investment spending will contribute to a contraction in the U.S. economy for the second straight quarter. Economists estimate a government report tomorrow will show gross domestic product shrank in the July-through-September period.
``We see businesses that have changed gears in reaction to the financial markets, worries about credit availability and worries about consumers,'' said Stephen Gallagher, chief U.S. economist at Societe Generale SA in New York, who forecast total orders would increase. ``It should lead to more decisive negative readings on capital spending in upcoming quarters.''
Federal Reserve policy makers, meeting today, are projected to lower interest rates further to help increase the flow of credit. Policy makers will cut the benchmark rate half a point to 1 percent, according to the median forecast in a Bloomberg News survey. The announcement is scheduled for about 2:15 p.m. in Washington.
Treasuries, Stocks
Treasuries gained and stocks fell. Benchmark 10-year note yields were at 3.80 percent at 10:00 a.m. in New York, from 3.85 percent late yesterday. The Standard & Poor's 500 Stock Index declined 1.1 percent to 929.8.
Economists projected orders excluding transportation equipment would fall 1.5 percent, after a previously reported 3.3 percent drop in August.
Total orders were expected to fall 1.1 percent, according to the median of 70 forecasts. The decline in August was revised to a 5.5 percent drop from the 4.8 percent decrease released previously.
Bookings for non-defense capital goods excluding aircraft, a measure of future business investment, fell 1.4 percent after a 2.2 percent decrease in August. Shipments of those items, used in calculating gross domestic product, increased 2 percent following a 2.1 percent drop.
Demand for transportation equipment climbed 6.3 percent after a 9.3 percent decrease in August, today's report showed. Orders for commercial aircraft jumped 30 percent after plunging 38 percent a month earlier.
Economists' Focus
The volatility in aircraft demand in August and September illustrates why economists prefer to exclude those figures when trying to determine underlying trends.
Orders for autos have also been volatile in the last couple of months. They rose 3 percent in September following an 8.8 percent drop a month earlier.
Boeing Co., the world's second-largest commercial planemaker, said it received 41 orders for aircraft in September, up from 38 the previous month. Still, the Chicago-based company had its third-quarter profits cut by 38 percent as a strike by about 27,000 machinists slowed deliveries. Workers yesterday agreed to vote on a new contract proposal on Nov. 1.
Some airlines have canceled or deferred their plane orders this year as the economy weakened. Southwest Airlines Co., the largest low-fare carrier, said this month it will add no more than 10 new Boeing aircraft, down nearly a third from an earlier projection.
Manufacturing Shrinks
National manufacturing reports signaled widespread declines in bookings as companies couldn't secure financing for big purchases. Manufacturing contracted in September at the fastest pace since the 2001 recession, the Tempe, Arizona-based Institute for Supply Management reported earlier this month.
Regional reports indicate the decline in manufacturing gained momentum along the East Coast in October as the credit squeeze deepened. The New York Fed's general economic index fell this month to the lowest level since record-keeping began in 2001. The Philadelphia Fed said manufacturing in its district shrank at the fastest pace in almost two decades.
The increase in shipments of non-defense capital goods excluding planes reported by Commerce today may lead some economists to boost forecasts for growth in the third quarter. Still, the decline in orders for such goods indicates growth in the last three months of the year will be less than currently anticipated.
GDP Report
Advance figures on gross domestic product, due from the Commerce Department tomorrow, may show the economy contracted at a 0.5 percent annual rate from July through September, according to a Bloomberg survey. It would be the second drop in a year and the biggest since the 2001 recession.
Auto-industry figures released this month show September purchases of cars and light trucks in the U.S. fell 27 percent, making for the worst sales month since 1991.
General Motors Corp., the largest U.S. automaker, said this week that it plans to halt production for a week at car plants in Kentucky and Michigan.
Whirlpool Corp., the world's largest appliance maker, said yesterday it will cut 5,000 jobs and forecast lower annual profit as the global credit crunch and U.S. housing slump clipped appliance sales.
Oct. 29 (Bloomberg) -- The Federal Reserve may lower its benchmark interest rate to 1 percent today and signal further reductions to levels unseen since Dwight Eisenhower was president.
Tumbling commodities prices and weaker consumer spending are slowing inflation, which officials described as a ``significant concern'' at their last scheduled meeting in September. Tomorrow, the Commerce Department will probably report that the economy shrank at a 0.5 percent annual rate in the third quarter, the most since the 2001 recession, economists predict.
The Fed ``will be very aggressive,'' said Mark Gertler, a New York University economist and research co-author with Fed Chairman Ben S. Bernanke. ``Inflation risks are off the table'' and ``the issue now is how bad the recession will be.''
He predicted the benchmark rate will be cut by half a point today, matching the median forecast of economists surveyed by Bloomberg News. Bernanke and his team could push borrowing costs to zero by June if the credit crunch intensifies, Gertler said.
The Fed has already cut the benchmark rate from 5.25 percent in the past 13 months and created six lending programs channeling more than $1 trillion into the financial system. Banks are still reluctant to lend to each other and the Standard & Poor's 500 Index is down almost 36 percent this year, even after yesterday's surge.
The FOMC is scheduled to announce its decision on rates at about 2:15 p.m. in Washington.
`Inadequate Growth'
``The predominant concern will be inadequate growth,'' said former Fed Governor Lyle Gramley, now a Washington-based senior economic adviser for Stanford Group Co., a wealth-management firm. ``If the economy shows additional signs of a deepening recession, I think the Fed will decide that the floor is not 1 percent.''
Gramley predicts that policy makers will again cut the main rate by 0.5 percentage point at their next scheduled meeting in December, pushing it toward levels last seen in 1958. ``Zero is a possibility,'' he said.
U.S. stocks swung between gains and losses before the Fed decision. The Standard & Poor's 500 Index fell 0.6 percent at 10:47 a.m. in New York. Borrowing costs eased, with the London interbank offered rate, or Libor, for three-month dollar loans dropping 5 basis points to 3.42 percent.
More evidence of weakness came today as orders for U.S. durable goods excluding transportation equipment fell in September, the government reported. The 1.1 percent drop in bookings of goods meant to last several years was less than forecast and followed a revised 4.1 percent decrease in August that was larger than previously reported.
`Weakening Demand'
European Central Bank President Jean-Claude Trichet said Oct. 27 he may reduce interest rates next week, citing ebbing inflation and ``weakening demand.'' The ECB, Fed and four other central banks trimmed rates by a half point on Oct. 8 in an unprecedented coordinated move.
After the emergency cut, the Fed signaled it may ease again, citing ``weakening of economic activity and a reduction in inflationary pressures.''
Most of the FOMC's statement today will focus on the financial crisis, including tightening credit conditions, said Robert Eisenbeis, a former Atlanta Fed economist.
The statement will also note falling energy prices and express ``less concern, as a result, about inflation,'' said Eisenbeis, chief monetary economist at hedge fund Cumberland Advisors Inc. in Vineland, New Jersey. Beginning today the central bank will probably cut in 0.50 percentage-point increments, stopping at 0.25 percent, he said.
Fed policy makers face increasing evidence the economy is already in a recession. Consumer confidence plunged this month, with the Conference Board's confidence index hitting its lowest level since records began in 1967.
Longest Slump
Payrolls fell last month by 159,000 for the biggest reduction in five years, according to Labor Department figures released on Oct. 3. Retail sales fell 1.2 percent in September, extending their decline to a third consecutive month for the longest slump in at least 16 years.
``Sharply increasing unemployment'' and other data indicate ``the probability has gone up substantially'' that the U.S. economy will begin to shrink, St. Louis Fed President James Bullard said Oct. 14.
The Fed cut the main rate to 1 percent in June 2003, leaving it unchanged for a year in response to concerns about deflation. Bullard and Dallas Fed President Richard Fisher have said the low rate stoked inflationary pressures.
Rising prices have faded as a concern in recent months. Americans expect inflation of 2.8 percent over the next five years, the slowest pace in a year, according to the Reuters/University of Michigan preliminary index of consumer sentiment on Oct. 17.
Global Recession
Crude oil fell to a 17-month low on Oct. 27 amid heightened concern that a global recession will erode consumption. The price of oil has tumbled 56 percent since reaching a record $147.27 on July 11.
With inflation abating, the FOMC may vote with no dissents. Fisher supported the last rate reduction after dissenting as recently as Aug. 5 out of concern about rising prices.
``With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures,'' Atlanta Fed President Dennis Lockhart said Oct. 20.
Cutting rates too far may hurt the money market mutual fund industry by making it difficult for the funds to attract deposits profitably, said Vincent Reinhart, the Fed's chief monetary- policy strategist from 2001 until September 2007.
``As the policy rate goes closer toward zero, rates get compressed and those business models are called into question,'' he said. If that concern is dispelled, the main rate ``could go to 1 percent'' while policy makers say risks are ``tilted toward economic weakness,'' indicating they may further pare rates.
New orders for durable goods increased 0.8% in September
New orders for durable goods increased 0.8% in September versus a consensus expected decline of 1.1%. Excluding transportation, orders fell 1.1% versus a consensus expected decline of 1.5%. Orders are down 3.6% versus a year ago, but down only 0.6% excluding transportation.
The strength in orders in September was concentrated in aircraft and motor vehicles. The weakest component of orders was primary metals.
When calculating business investment for GDP purposes, the government uses shipments of non-defense capital goods excluding aircraft. That measure increased 2.0% in September, rebounding from a decline of 2.1% in August. These shipments were up at a 0.1% annual rate in Q3 versus the Q2 average.
Unfilled orders rose 0.4% in August and are up 12.0% versus last year.
Implications: Business investment was stronger than the consensus expected in September, even factoring in downward revisions to August. “Core” shipments (excluding defense and aircraft) remain above the year-ago level. Durable goods inventory data showed weakness, however, suggesting real GDP contracted at about a -0.3% annual rate in Q3. The advance report on GDP, reported tomorrow morning, may show even greater weakness and then get revised upward in the months ahead. The Federal Reserve will make a decision on short-term interest rates early this afternoon and we still expect a 50 basis point cut in the federal funds rate to 1%, equaling the low hit in 2003-04.
Tuesday, October 28, 2008
Latin America and the United States
The more things change
The neighbours’ tepid enthusiasm for Barack Obama
Adios, Señor BushOF THE two candidates in the American presidential election, it is John McCain who knows something about Latin America. Not only was he born in Panama, he also visited Colombia and Mexico in July. He thinks the United States should ratify a free-trade agreement with Colombia and, at least until it became politically toxic, wanted to reform immigration policy. Ask him who the United States’ most important friends around the word are and he pretty quickly mentions Brazil.
And yet if they had a vote, Latin Americans, like Europeans, would cast it for Barack Obama—though without much enthusiasm. Preliminary data from the latest Latinobarómetro poll, taken in 18 countries over the past month and published exclusively by The Economist, show that 29% of respondents think an Obama victory would be better for their country, against only 8% favouring Mr McCain. Perhaps surprisingly, 30% say that it makes no difference who wins, while 31% claim ignorance. Enthusiasm for Mr Obama is particularly high in the Dominican Republic (52%), Costa Rica, Uruguay and Brazil (41%). In Brazil, six candidates in this month’s municipal elections changed their names to include “Barack Obama” in them.
The poll suggests that support for Mr Obama is greater among better-educated Latin Americans. Marta Lagos, Latinobarómetro’s director, says the relatively widespread indifference shows the extent to which the United States has lost influence in the region in recent years.
An adopted Texan with a Mexican sister-in-law, George Bush came to office promising to strengthen ties with the neighbours to the south. The terrorist attacks of September 2001 introduced new priorities. Latin Americans were hostile to the war in Iraq, perhaps because some countries in the region had suffered American-backed efforts at regime change in the past. Mr Bush was seen as doing little to help when Argentina’s economy collapsed in 2001. His administration then seemed to endorse a failed coup attempt against Venezuela’s leftist president, Hugo Chávez.
In Mr Bush’s second term, American policy towards the region has been very different in tone. The administration has sought to work with allies such as Brazil, Mexico, and Chile. It has tried hard not to be provoked by Mr Chávez, and by other radical leftist governments. Mr Bush has talked about the need to fight poverty. Whoever wins next month is likely to adopt a broadly similar approach.
But several of the United States’ foreign-policy concerns in Latin America—trade, migration, illegal drugs and Cuba—are also domestic issues. Take trade. Mr McCain is a committed free-trader. Mr Obama has said he will seek to “renegotiate” the North American Free-Trade Agreement (NAFTA) with Canada and Mexico. He also opposes the trade agreement with Colombia, citing murders of trade unionists there (although these have fallen steeply, and their perpetrators increasingly face justice). This alarms Mexican officials and disappoints those of Colombia. But Mr Obama adopted this stance because voters worry about the loss of manufacturing jobs, and because it chimes with his union backers.
If Mr Obama wins, he may set up a general review of trade policy and of the safety net for those who lose their jobs. That might make it politically possible for him not to sour relations with the neighbours by trying to reopen NAFTA, reckons Michael Shifter of the Inter-American Dialogue, a think-tank in Washington, DC. He thinks that the Colombia trade agreement will eventually be approved.
Less separates the two candidates on migration. Both support stronger border control. Neither offers anything new on illegal drugs (both men voted for the Mérida Initiative, granting aid to Mexico, and both back Plan Colombia). There is a clearer difference on Cuba. Mr McCain is an enthusiastic supporter of the American economic embargo against the island. In a speech in Miami, Mr Obama promised to lift Mr Bush’s restrictions on family visits and remittances by Cuban-Americans, but not the embargo itself.
Mr Obama pledged to increase foreign aid to Latin America, but financial turmoil is likely to put paid to that. Unlike Mr McCain, he supports the tariff against Brazilian ethanol. Yet Brazil’s government would feel more comfortable with Mr Obama than it has with Mr Bush, according to one minister. That goes for many of the region’s left of centre governments.
Would an Obama victory serve to reduce anti-Americanism in the region? Ms Lagos reckons that it might, because expectations of change are so low. It would be harder for Mr Chávez to portray Mr Obama as “the devil”, as he did Mr Bush. But the issues that divide the United States from Mr Chávez and his friends are not about to disappear, says Mr Shifter.
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