You wouldn’t know it to hear officials talk, but the strong yen is not Japan’s main problem. The Bank of Japan’s latest moves on Monday didn’t weaken the currency — though that is one broad objective of fiscal and monetary stimulus. In any case, the trade-weighted yen is weaker than its real 1990-2010 average and Japanese exports are still rising. Export lobbies may have the government’s ear, but intervention could make Japan’s domestic predicament worse.
When the Democratic Party of Japan took office last year, its leaders talked about putting more emphasis on Japan’s domestic economy rather than the needs of major exporters, which had been favored by Liberal Democratic Party administrations since 1955. The DPJ’s first finance minister, Hirohisa Fujii, said at his introductory press conference last September that he was opposed in principle to currency intervention because it could distort the economy.
U.S. Federal Reserve Chairman Ben Bernanke said in his Jackson Hole speech on Friday he would fight deflation — but he ignored the federal deficit. Even Japan has not experienced sustained deflation, while the U.S. deficit remains at record levels. Bernanke’s diagnosis and treatment of a phantom disease are unlikely to produce faster growth.
Sir Ralph Bloomfield Bonington, the quack in Shaw’s “TheDoctor’s Dilemma,” offered a single treatment for all diseases — to “stimulate the phagocytes.” In a similar vein, Bernanke appears to regard the anti-deflationary treatment that the Fed should have applied in 1930-32 as appropriate for all subsequent economic ailments.
South African president Jacob Zuma wants to join the BRICs. The likely deluge of foreign investment from membership of the club representing the biggest fast-growing economies would bring huge benefits. But Zuma has plenty to prove — including that he can avoid the BRICs’ worst failings.
The BRIC concept coined by Goldman Sachs, referring to Brazil, Russia, India and China, has attracted heavy global investment flows. That has speeded the four countries’ growth — although sometimes, as in Russia in 2007, it has also produced dangerous bubbles. With 25 percent unemployment and one of the world’s biggest gaps between rich and poor, South Africa would greatly benefit from a similar surge in foreign investment to employ its people and improve their living standards.
If U.S. railroad Norfolk Southern can issue 100-year bonds, why not the U.S. Treasury? Longer maturities than the current 30-year maximum would reduce refinancing needs and appeal to institutions. But investors might well demand more return for the risks than Treasury would be willing to pay.
Norfolk Southern’s new bonds yield about 0.9 percentage points more than the company’s 30-year debt. There’s a similar spread between yields on Britain’s perpetual War Loan paper and 30-year gilts. Based on the current 30-year Treasury yield of around 3.6 percent, the government would probably expect to sell 100-year bonds at a yield of no more than about 4.5 percent.
The Fed has pointed its policy the wrong way. Spooked by slowing growth, the Federal Open Market Committee decided to loosen money marginally at its latest meeting on Tuesday. This was done by agreeing to reinvest the runoff in the central bank’s agency and mortgage-backed securities portfolio into longer-term government debt.
However, weaker productivity has now joined rising global prices to add to U.S. inflationary pressure. The result is that the Fed has put itself in position to lag any economic shift.
U.S. state and local finances have become truly alarming. At $144 billion the combined budget gap this year for the 50 states is higher than the $133 billion of the previous year. What’s more, last year’s federal stimulus funds, which helped mitigate the gap, will end by December. Since their finances are highly dependent on the economy, if the recovery slows or double-dips, states and local governments could suffer more pain than any other player save the long-term unemployed.
Much of states’ current budgetary problems result from bad decision-making. According to a Federal Reserve Bank of San Francisco study, if California and Oregon had kept per capita state expenditures and taxes constant over the past three years, both states would have had budget gaps for the current year of about 20 percent of state spending. In practice, California continued to increase spending, while Oregon imposed substantial tax increases and restrained spending. Consequently California’s actual 2009-10 budget gap was 37 percent of state spending while Oregon’s was 7 percent.
Would-be billionaires often say they’re discouraged by high tax rates. For example, the British Venture Capital Association complained the UK’s increase in the tax rate on capital gains to 28 percent, would damage capital formation. The latest World Wealth Report from Merrill Lynch and Cap Gemini suggests otherwise.
The report looks at what used to be called rich people, who are now known as high net worth individuals (HNWI). The cut-off is investible capital of $1 million.
The search by global investors for safe havens is looking increasingly desperate. Net foreign investment flows to long-term U.S. securities were $141 billion in March, the most since records began, of which $108 billion was into Treasuries. Rather than a touching sign of confidence in Uncle Sam, this may derive from a more simple consideration: there’s nowhere else to go.
March saw rapidly rising investor concern about Greece’s debt position and the future of the euro, so it was not surprising that flows into American securities increased sharply. Even so, the U.S. budget position is not hugely superior to Greece’s — although its debt levels are lower — and there is as yet little action to improve it. So the flow to U.S. Treasuries, most of it from private investors presumably with other choices, is surprising.
It sounds like a gold bug’s dream. But looking back to the last inflation-adjusted peak price in 1980, it’s far from impossible that the gold price could soon go above $5,000 an ounce.
The potential level of a new peak can be estimated in several ways. Based on consumer price inflation, the $875 per ounce high seen in 1980 is equivalent to around $2,400 today, almost twice the current gold price. But there’s a case for taking account of economic expansion as well as price inflation.
The world’s economic output has increased about six-fold since 1980. Scale up the peak 30 years ago by that multiple, and the gold price could top out at around $5,300.
Gold can also be regarded as an alternative to money. Broad global money supply, known as M3, is now in dollar terms about 10 times what it was in 1980. The total gold supply has also increased to some 170,000 tonnes from 110,000 tonnes over the same period as more of the metal has been mined. Scaling up by money supply and deflating by the gold supply, the 1980 peak price would be equivalent to about $5,700 an ounce today.
Looking at money supply another way, today’s potential gold price would be a bit lower than that. A narrower measure of global money, M1, is currently estimated at about $17 trillion. If the 170,000 tonnes of gold mined through history were to substitute for this, the gold would be worth around $3,100 per ounce. But that wouldn’t account for the tendency of the thinly-traded gold market to overshoot sometimes to the upside, as for instance in 1980, and sometimes to the downside.
Of course, there is a considerable chance that gold and other commodity prices will peak at a lower level. But if a four-fold increase over a couple of years from today’s gold price to more than $5,000 an ounce seems impossibly extreme, that was the trajectory in 1978-1980. If governments continue to print money, whether for economic stimulus or to stave off defaults by themselves or others, fear of widespread currency debasement and the consequent inflation could create the conditions for just such a spike.
The credit crisis would not have been as bad if investment banks’ risk management systems worked well. But the systems rely on sophisticated mathematical models that have a fundamental flaw — they grossly underestimate “tail risk”. This problem can be solved fairly easily.
In a way, this is a higher technical dispute, about the arcane details of the calculation of Value at Risk (VaR), the prime measure of the riskiness of trading books. To non-mathematicians, the possible answers sound daunting: Gaussian, Cauchy, and Pareto-Levy. But the underlying question is straightforward: how often and how badly do markets blow up?