From Volume 5, Issue Number 11 of EIR Online, Published Mar. 14, 2006

World Economic News

Bank of Japan Cuts Liquidity; Keeps Rates at Zero—for Now

In a first step to ending its zero-interest-rate policy, the Bank of Japan (BoJ) on March 9 decided to drastically cut the amount of excess liquidity which it guarantees for the Japanese interbank money market. Since Spring 2001, the target had been set in the range of 30 to 35 trillion yen, (almost $300 billion). Now, the target has been cut down by about 80% to 6 trillion yen (about $50 billion). The reduction will be made gradually over several months in order to avoid disruptions. While the reduced amount of liquidity is expected to slowly increase market rates, the BoJ prime rate remains at zero for the moment.

This compromise decision was announced by the bank after massive pressure from the highly indebted Japanese government, and much more intense pressure behind the scenes from the international financial community. In view of coming rate increases in Japan, Europe, and the U.S., which would undermine the various global "carry trades," there have already been two rounds of panic selling in recent weeks, each hitting stocks, bonds, and currencies of almost every so-called "emerging market" around the globe.

The first round was triggered by the "Iceland crash" in February, while the second appeared on March 6-7; on March 7 alone, emerging stock markets suffered their biggest overall crash in the last two years. Stock markets in Russia, Turkey, and throughout Latin America plunged by 3% to 6%, risk premiums on respective government bonds shot up, and currencies like that of Brazil, Turkey, and South Africa were sinking. The sell-off was accompanied by panic sales on commodity markets, in particular, effecting base metals such as copper, zinc, and aluminum, all at multi-year highs due to hedge-fund speculation.

Commodity Market May Be First To Go

The commodity market may be the first casualty from the carry-trade collapse, said March 9. Because the commodity investors (hedge funds) are all in long positions (betting on further price rises), "one key impact to watch is how the tightening [in liquidity due to rising interest rates] weighs on commodity prices, and whether it forces an unwinding of commodity-related trading strategies." While lower commodity prices should be good for the economy, the investor website warns that there are "sizeable financial positions" betting on rises.

BIS Quarterly Report Highlights Emerging-Market Bubble

The overview of the latest quarterly report of the Basel, Switzerland-based Bank for International Settlements (BIS), released March 9, headlined "Emerging markets soar to historic highs," highlight financial bubble in this sector, itself a byproduct of the worldwide "carry trades." The BIS notes: "Asset prices in emerging markets rallied to record highs early in the new year. Foreign investors snapped up emerging-market bonds and equities, pushing indicators of valuations towards and in some cases beyond the upper end of their historical range." On top of "already impressive gains in 2005," bonds, equities, and currencies of emerging markets again "rallied strongly in January and February."

It continues: "Equities posted the largest gains. Almost all emerging equity markets had recorded double-digit increases in 2005, led by Egypt, Colombia and Saudi Arabia, where prices had more than doubled. This rally "was driven in large part by massive inflows of foreign capital." At the same time, emerging markets were able to sell $231 billion of bonds on international markets in 2005, an all-time high and 52% more than in the previous year. Such bonds, on the average, were offering yields of almost 12% in 2005, according to private estimates.

Another high-yield, high-risk market receiving huge capital inflows in 2005 was the corporate bond market, including junk bonds: "In recent months there has been no let-up in the rapid pace of mergers and acquisitions (M&As), including leveraged buyouts (LBOs). Acquisitions totalling $3.2 trillion were announced in 2005, up almost 30% from 2004 and the highest level since 2000. More worry for credit investors, LBOs in 2005 reached their highest level since the buyout frenzy in the late 1980s—a frenzy which contributed to a sharp increase in corporate defaults soon afterwards. Furthermore, in contrast to the 1980s, the recent increase in LBO activity was not limited to the United States. Indeed, more than half of all deals involved firms outside the United States, mainly in Europe but also in Asia."

ADB Calls for Investment in East Asian Infrastructure

Addressing the Mekong Development Forum at Singapore on March 8, Asian Development Bank vice president Liqun Jin said: "High savings rates and large export earnings that the stronger Asian economies have experienced through several decades of outward-looking growth, have enabled them to build up enormous capital funds and foreign exchange reserves. The irony, however, is that much of these financial resources are currently invested outside the region, while the region hungers for investment funds."

Jin said, "The challenge, therefore, is to keep these funds in Asia, invested in Asia to support the region's development, and, in addition, to attract foreign capital into the region's emerging economies." Jin said East Asia's infrastructure needs an estimated $1 trillion over the next five years, and this can be met by keeping some of the region's vast financial reserves for investments at home.

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