In this issue:

BIS Highlights Risks to Global Financial System

Is the Bond Bubble About To Pop?

Central Bankers About To Bring Back 'Hyperinflation'?

Argentina Acts To Curb Short-Term Speculative Flows

Will the Lights Go Out in Britain?

U.S. Collapse Spreads to Mexico's Auto Industry


From Volume 2, Issue Number 27 of Electronic Intelligence Weekly, Published July 8, 2003

World Economic News

BIS Highlights Risks to Global Financial System

In its annual report, released June 30, the Bank for International Settlements (BIS) points to the "relative reliability of the global financial system, particularly banks," in spite of a series of unprecedented shocks in recent years. However, "some strains have already begun to appear, and these would be likely to worsen were the anticipated expansion to falter." In such a case, stock markets would again sink, credit spreads would go up, and finally, property prices, presently at record levels, in a number of countries, would go down. "All of these price effects would further impair corporate and household balance sheets."

"Even if such a combination of events might be thought unlikely, it would surely be prudent for policymakers to reflect on the possible effects on the health of the financial system. In a number of countries, the proportion of bank loans related to real estate has been rising steadily, indicating a growing exposure to price decreases. Further declines in the prices of financial assets would prove particularly uncomfortable for banks in Germany and Japan.

"Further declines in the prices of financial assets might also cause difficulties for insurance companies and pension funds that have already been hard hit." The implications of further pension fund losses could be far-reaching, notes the BIS report, "At the extreme, parent companies could be downgraded or even forced into bankruptcy if the losses were large enough."

Another factor contributing to financial vulnerabilities" is the fact that "systems, particularly for risk mitigation, grow ever more complex, legally challenging, and technology-dependent." Therefore, "the likelihood that something will go wrong clearly rises." Another concern is the "increased volatility in financial markets, and the possibility that some financial institutions might have insufficient means in place to protect themselves. A concrete example might be the possibility of sudden, sharp increases in long-term interest rates and the effects on institutions that essentially borrow short and lend long."

A third set of concerns is the tendency towards fewer and larger financial institutions: "With large firms increasingly trading among themselves, perceived difficulties with one counterparty might very quickly involve others. Moreover, large players can move markets in ways that could affect the cost and availability of needed hedging. In this way, idiosyncratic shocks could conceivably turn systemic."

Is the Bond Bubble About To Pop?

This is the question posed in an article, "Investors fear end of bond bubble is in sight," in the Financial Times July 3, by Charles Batchelor and Ed Crooks, who also seem to have some fears of their own. Excerpts follow:

"Investors shunned British and German government bond market auctions on Wednesday [July 2], fuelling fears that the three-year old bond "bubble" has passed its peak. The poor response coincided with a further fall in the price of U.S. Treasury bonds, which hit a seven-week low during the day before recovering by the close.

"Demand for bonds is being hit by concern about deteriorating public finances in most large economies and by renewed interest in equities as hopes of economic recovery rise and fears of deflation fade.

"But a fall in bond prices could threaten to choke off the stock market revival and undermine recovery."

This is the idea repeated ad nauseam in the article. After reporting figures on low bond sales in Britain and Germany July 2, the FT quotes Ciaran O'Hagan, fixed-income strategist at Lehman Brothers, who said the German government bond auction was "the worst I have ever seen in my 12 years of following the market."

The FT continues: "Since the end of the share price bubble in 2000, a flight away from equities and into bonds has driven bond prices up—an ascent many analysts have seen as another bubble waiting to burst.... a drop in bond prices could upset the recovery in share prices.... 'The biggest prop to the stock market has been low bond yields,' said Eric Lonergan of Cazenove. 'We have just had a very strong quarter for equities, and now one of the supports for that is being taken away.'

"Falling bond prices—which mean rising long-term interest rates—also threaten to undo efforts by governments to establish a robust global recovery. Rising bond prices have cut the cost of fixed-rate mortgages in many countries and fuelled consumer spending, particularly in the U.S. Companies have also been able to refinance debts more cheaply. These supports for growth would be undermined if bond prices continued to fall," and so on and so forth.

Central Bankers About To Bring Back 'Hyperinflation'?

In his column for the German daily Die Welt June 30, Hong Kong-based Swiss fund manager Marc Faber stated that amidst all the talk about deflation, we are already dealing with "hidden inflation" in the U.S. right now. He recalled the "inflation panic" in the 1978-81 period, when investors bet on an oil price of $80 per barrel, everybody was buying gold, and the Fed was pushing up interest rates to 15% and more. Today, it seems to be the other way around: Investors are fearing deflation and central bankers on a worldwide scale are engaged in "extreme monetary expansion, in particular in the U.S. and Japan. The overall U.S. indebtedness in the meantime has risen from 125% to 300% of Gross Domestic Product," Faber writes.

Official price inflation is still low because of cheap imports from Asia, he says. But all the other traditional symptoms of inflation—rising trade and current account deficits, currency weakness, rapidly rising real-estate prices—have already been around for more than a year in the United States. Last week, there was a huge sell-off on the bond markets, pushing up Treasury yields, in spite of the fact that the Fed had just cut short-term interest rates. Any news on rising inflation could now trigger a huge bond-market crash, Faber warns.

"Of course, the architects of the several financial bubbles—Greenspan and Bernanke—would then pump even more liquidity into the system, just as German Finance Minister Helfferich did in the early 1920s, thereby laying the foundation for hyperinflation. Over the long run this will not work. In view of present monetary and fiscal policies in the U.S. and Japan, I have lost my confidence in long-term securities," Faber concludes.

Argentina Acts To Curb Short-Term Speculative Flows

The Argentine government will implement measures to curb short-term speculative flows, by requiring investors to keep their money in the country for at least 180 days, according to a June 25 announcement. Finance Minister Roberto Lavagna had indicated even before President Nestor Kirchner took office on May 25, that he was working on such a measure. The announcement came one day after IMF Managing Director Horst Koehler left the country, and although no date for its implementation has yet been announced, it has already provoked rage among Anglo-American financial circles, who threaten that this will "undermine confidence" in the country, by asserting, even partially that the Argentine government believes "you can invest in my country, but only on my terms," as one London financial analyst put it. All Argentine bonds dropped sharply on June 26, after the Merval stock market had fallen by almost 7% the day before.

Lavagna said that the measure, which applies to non-trade capital, is intended to prevent sharp fluctuations in the dollar, which pose a significant risk to the economy. "We want to make it clear that short-term speculative flows are not compatible with the Argentine economy," he said. Over the past month, hot money increased to $900 million, compared to $550 million three months ago. Asked about the measure, IMF External Relations Director Tom Dawson responded tersely, "We will be looking at it further with the authorities."

Will the Lights Go Out in Britain?

The lights could go out in Britain before 2020, due to short-sighted energy policy, states a report published on July 1 by the Institution of Civil Engineers (ICE). It reveals that, within a generation, Britain will become completely reliant upon energy sources supplied via pipelines from politically unstable countries thousands of miles away. The "State of the Nation 2003" report highlights a potential 80% shortfall in meeting the country's energy demands from current supplies by 2020, and points to the possibly cataclysmic effects of becoming reliant upon unsecured, imported fuel supplies.

Tom Foulkes, ICE Director General, says: "This country has been largely self-sufficient in electricity generation for the past 100 years. We have been able to ride through a succession of energy crises, such as oil in 1973, coal in the early 1980s, and the self-inflicted petrol crisis of 2000. All of these had the potential to inflict serious economic damage, but this was largely avoided by the fuel mix and diversity available at the time. This is about to change dramatically."

Currently, the British generation mix for electricity is approximately 32% coal, 23% nuclear, 38% gas, 4% oil, with 3% others and renewables. Emission constraints mean that the U.K.'s coal-powered generating plants will close shortly after 2016. And, the ICE release adds, "only one nuclear power station will remain operational beyond 2020, due to the government's failure to invest in maintaining and upgrading Britain's nuclear power program."

David Anderson, chair of ICE's Energy Board, warned that if the government doesn't act, "a return to the blackouts that marked the 'Winter of Discontent' and the country grinding to a halt are very real possibilities in less than 20 years' time."

U.S. Collapse Spreads to Mexico's Auto Industry

Volkswagen, one of the largest auto producers in Mexico, announced that they will cut production by 23% and fire 2,000 workers at the beginning of August, due to the collapse of their sales to the United States. They will produce 60,000 fewer cars this year than they had planned. Workers are attempting to offer pay cuts, shorter work weeks—anything to keep a job.

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