USA TODAY: The looming national benefit crisis

The looming national benefit crisis
By Dennis Cauchon and John Waggoner, USA TODAY

The long-term economic health of the United States is threatened by $53 trillion in government debts and liabilities that start to come due in four years when baby boomers begin to retire. (Related graphic: U.S. economy threatened by aging of America)

The "Greatest Generation" and its baby-boom children have promised themselves benefits unprecedented in size and scope. Many leading economists say that even the world's most prosperous economy cannot fulfill these promises without a crushing increase in taxes — and perhaps not even then.

Neither President Bush nor John Kerry is addressing the issue in detail as they campaign for the White House.

A USA TODAY analysis found that the nation's hidden debt — Americans' obligation today as taxpayers — is more than five times the $9.5 trillion they owe on mortgages, car loans, credit cards and other personal debt.

This hidden debt equals $473,456 per household, dwarfing the $84,454 each household owes in personal debt.

The $53 trillion is what federal, state and local governments need immediately — stashed away, earning interest, beyond the $3 trillion in taxes collected last year — to repay debts and honor future benefits promised under Medicare, Social Security and government pensions. And like an unpaid credit card balance accumulating interest, the problem grows by more than $1 trillion every year that action to pay down the debt is delayed.

"As a nation, we may have already made promises to coming generations of retirees that we will be unable to fulfill," Federal Reserve Chairman Alan Greenspan told the House Budget Committee last month. (Related story: Americans' views on the benefit quandary)

Greenspan and economists from both political parties warn that the nation's economy is at risk from these fast-approaching costs. If action isn't taken soon — when baby boomers are still working and contributing payroll taxes— the consequences may be catastrophic, some economists say.

The worst-case scenario is a sudden crisis — perhaps a major terrorist attack or a shutoff of oil from the Middle East — that triggers a loss of confidence by investors in the U.S. economy. Foreign investors refuse to lend more money to the government to finance its deficits; drastic tax increases and benefit cuts occur suddenly; the dollar's value plummets, which raises the cost of imported goods; and a severe recession or depression results from falling incomes.

A softer landing: The USA acts swiftly and becomes more like Europe. Taxes are higher, retirement benefits are less generous but widely distributed; health care costs are controlled; and the economy is sound but less productive.

Big payments on the debt start coming due in 2008, when the first of 78 million baby boomers — the generation born from 1946 to 1964 —qualify at age 62 for early retirement benefits from Social Security. The costs start mushrooming in 2011, when the first boomers turn 65 and qualify for taxpayer-funded Medicare.

Early warning signs

But Americans needn't wait until 2008 or 2011 to see firsthand the escalating costs of these benefit programs. Medicare last month announced the largest premium increase in the program's 39-year history. In 2004 alone, federal spending on Medicare and Social Security will increase $45 billion, to $789 billion. That one-year increase is more than the $28 billion budget of the Department of Homeland Security.

Many economists say a failure to confront the nation's debt promptly will only delay the inevitable.

"The baby boomers and the Greatest Generation are delivering an economic disaster to their children," says Laurence Kotlikoff, a Boston University economist and co-author of The Coming Generational Storm, a book about the national debt. "We should be ashamed of ourselves."

USA TODAY used official government numbers to compute what the burden means to the average American household. To pay the obligations of federal, state and local government:

•All federal taxes would have to double immediately and permanently. A household earning $100,000 a year would see its federal taxes double from an average of about $20,000 to $40,000 a year. All state taxes would have to increase 20% immediately and permanently.

•Or, benefits for Social Security, Medicare and government pensions would have to be slashed in half immediately and permanently. Social Security checks would be cut from an average of $1,500 per month for couples to $750. Military pensions would drop from an average of $1,782 per month to $891. Medicare spending would fall from $7,500 to $3,750 annually per senior. The Medicare prescription-drug benefit enacted last year would be canceled.
•Or, a combination of tax hikes and benefit cuts — such as a 50% increase in taxes and a 25% reduction in benefits — would avoid the extremes but still require painful changes that are outside the scope of today's political debate. Savings also could come in the form of price controls on prescription drugs, raising retirement ages and limiting benefits to the affluent.

Every solution has the potential to damage the economy by reducing disposable income or diverting economic resources.

The estimates computed by USA TODAY are similar to ones by government watchdog agencies such as the Congressional Budget Office and the Government Accountability Office and respected think tanks such as the conservative American Enterprise Institute, the liberal Brookings Institution and the non-partisan Urban Institute.

"Political leaders know this is a big problem," says Glenn Hubbard, chairman of the Council of Economic Advisers for President Bush from 2001 to 2003. "I know the president is keenly aware. But in an election year, it's not easy to talk about. The solutions may be very painful. If he is re-elected, I think he will make this a top priority next year. I hope so."

"Economists agree this cannot go on," says Joseph Stiglitz, President Clinton's chief economic adviser from 1995 to 1997. "We can borrow and borrow, but eventually there will be a day of reckoning."

Economist James Galbraith of the University of Texas in Austin is a rare optimist in this debate. "I'm not at all concerned about Medicare or Social Security," Galbraith says. "Unless the government goes broke, Medicare isn't going to go broke, and the U.S. government isn't going to go broke because it can print money."

Galbraith says the country can handle higher tax rates, as Europeans do, and can save money by cutting spending elsewhere, such as on defense, and by implementing a Canadian-style health care system that uses private doctors and hospitals but has the government set prices and pay the bills.

"We are an enormously rich country," he says. "Providing health care and a modest living for our elderly is certainly something we can afford."

An aging population

Social Security was created in 1935 to help the elderly avoid poverty during the Great Depression. Medicare was established in 1965 to provide health care for the elderly, who were finding it increasingly difficult to afford medical care. But the aging of America and a declining birth rate have put these programs on a collision course with financial reality.

When the government set 65 as the retirement age in the 1930s, most people didn't live that long. But life expectancy for women has increased from 66 to 80 since 1940 and for men from 61 to 75.

Meanwhile, the birth rate has dropped from 25 births per 1,000 residents in the 1950s to just 15 today. The lower birth rate ultimately means fewer workers paying taxes to finance Social Security and Medicare benefits for the rapidly growing population of people 65 and over.

Medicare has had about 3.3 workers paying taxes for every recipient for the past 30 years. Baby boomer retirements will reduce that to just two workers supporting every Medicare recipient in 2040.

Immigration has helped offset some of the decline in birth rates. But immigration rates would have to increase by five or 10 times — above the recent peak of 1.2 million in 2001, legal and illegal — to provide enough workers and their payroll taxes to boost Medicare.

Medicare recipients are growing older and more expensive, too. Annual medical costs for an 85-year-old are double those of a 65-year-old. Federal spending per Medicare recipient will average $7,500 this year. The official projection for 2050: $26,683 per recipient in 2004 dollars.

A problem in plain view

The scope of the problem is no secret in Washington.

Medicare and Social Security trustees report the obvious every year: The system has no way to pay for itself, even under the rosiest scenarios. The Congressional Budget Office regularly updates Congress on the liabilities.

Bush's budget for the fiscal year that began Friday spells out the numbers in detail and concludes, "These long-term budget projections show clearly that the budget is on an unsustainable path."

Comptroller General David Walker, the government's chief accountant, travels the nation warning of the impending crisis. "I am desperately trying to get people to understand the significance of this for our country, our children, our grandchildren," Walker says. "How this is resolved could affect not only our economic security but our national security. We're heading to a future where we'll have to double federal taxes or cut federal spending by 50%."

But documentation of the problem hasn't prompted political action to address it. The $4.2 trillion national debt has generated some debate in Congress and the presidential campaign. But the government's obligations for Medicare and Social Security are 10 times the size of the national debt.

"We have instructed our politicians not to tell us about this problem," says Boston University economist Kotlikoff. "If they even mention cuts to Social Security, we vote them out of office."

Grim financial statement

To bring attention to the problem, USA TODAY prepared a consolidated financial statement for taxpayers, similar to what corporations give shareholders. The newspaper totaled federal, state and local government liabilities, taken from official documents.

Key findings:

•Total hidden debt. Federal, state and local governments today have debts and "unfunded liabilities" of $53 trillion, or $473,456 per household. An unfunded liability is the difference, valued in today's dollars, between what current law requires the government to pay and what current law provides in projected tax revenue.

•Social Security. The retirement program has $12.7 trillion in obligations it cannot meet for current workers and retirees at the current Social Security tax rate.

•Medicare. The health care program has a $30 trillion unfunded liability for people now in the system as workers or beneficiaries. The $30 trillion reflects the value today of the more than $200 trillion in deficits over 75 years to cover current workers and retirees at existing levels of benefits, tax rates and premiums. Medicare's new prescription-drug benefit, which starts in 2006, accounts for $6.9 trillion of the program's financial ill health.

How much is $30 trillion? The gross domestic product, the entire economic output of the USA, was $11 trillion last year.

"These numbers are staggering in their magnitude," says economist Thomas Saving, whom Bush appointed as a public trustee on the Medicare and Social Security board. "But when I testify before Congress, I'm the only one saying, 'We have a funding problem.' Everyone else is testifying for more benefits."

Like a home mortgage

The $53 trillion in liabilities is like a mortgage balance: That's what it would cost to pay off the debt now. The actual cost would be higher because of interest payments. A $100,000 mortgage at 5% interest, for example, actually requires $193,000 in income to repay over 30 years.

Under corporate accounting rules, a corporation would record a $100,000 liability on its books if it promised to pay $193,000 in medical benefits over 30 years. That liability would reduce profits immediately, when the promise was made, although the money would be paid over 30 years. Otherwise, shareholders could be fooled into thinking that the company was better off than it really was.

In fact, the company had committed $193,000 in future revenue — worth $100,000 today — to a retiree and couldn't use the money for shareholder profits.

Government doesn't follow this accounting rule. If it did, the federal deficit in 2004 would be $8 trillion, not $422 billion. The $8 trillion reflects the value of new financial obligations Congress approved without any way to pay for them,plus the year's operating deficit.

Government accounting rules are more lenient because, unlike a business, Congress can take whatever money it needs through taxes and renege on promises by passing new laws. Theoretically, the president and Congress could end all health care for the elderly tomorrow and cease Social Security payments the next day — or double or triple tax rates to pay the bills.
That's why AARP, a non-partisan lobbying group for people over 50, says the unfunded promises of Medicare and Social Security are less worrisome than they appear.

"The reason we make companies fund their pension liabilities is because it's uncertain they'll be around in the future. That doesn't apply to government," says John Rother, AARP's research director. "The size of the liabilities isn't relevant, nor is how much we put aside today. What matters is how healthy will the economy be in the future."

He agrees that Medicare has a long-term funding problem but says the nation's entire health system is the issue, not Medicare.

Alan Auerbach, director of the Burch Center for Tax Policy and Public Finance at the University of California-Berkeley, says people are understandably skeptical about gloomy predictions. But he says these numbers are not guesses.

"We can't predict major wars or major inventions," he says. "But we do know the baby boomers aren't going to disappear. We know pretty well that health care costs will rise because of new technology. I wish these were worst-case scenarios, but they're rather cautious best guesses. It could be much worse."

A bill coming due

The heart of the problem is that the Greatest Generation and baby boomers have promised themselves retirement benefits so generous — and have contributed so little to financing them — that even the most prosperous economy in history cannot pay the bill.

Consider a married couple who throughout their lives earned the median income — the amount at which half of Americans make more and half make less — and who will retire at age 65 next year. They earned $46,400 in their final year of work.

Mr. and Mrs. Median would get a joint Medicare benefit valued at $283,500, the Urban Institute estimates. That's the present value of the benefit — what it's worth today — not the larger amount the government will actually pay over the years. But the couple would have paid only $43,300 in Medicare taxes (valued in 2004 dollars). Taxpayers lose $240,200 on the deal.

But the Medians' good fortune doesn't end there. They also qualify for $22,900 in annual Social Security benefits, which rise annually with inflation.

Present value of the Social Security benefit: $326,000. Present value of Social Security taxes paid over a lifetime: $198,000.

Net loss to taxpayers: $128,000.

And the situation is worse than that. The federal government didn't save the money that the Medians paid in Medicare and Social Security taxes. It spent that money as it came in on other things — defense, education, past Medicare costs, etc. So the Social Security and Medicare taxes paid by Mr. and Mrs. Median won't help offset the cost of their benefits. The Social Security and Medicare trust funds have no money, only IOUs that other taxpayers must repay.

"These mythical trust funds are a financial oxymoron — they can't be trusted and they aren't funded," says Peter Peterson, a businessman and Commerce secretary under President Nixon who wrote the best seller Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It.

Because the trust funds have been spent, taxpayers must come up with the full $609,500 that Mr. and Mrs. Median are entitled to under Medicare and Social Security. And the Medians are a bargain compared with what their 45-year-old children will cost.

Social Security is structured so that future generations get increasingly large benefits. And Medicare benefits rise with soaring health care costs.

The Medians' children would receive Social Security and Medicare benefits with a present value of $884,000 in 2004 dollars when they turn 65, according to the Urban Institute. That's 45% more than their parents would get.

For Hubbard, now dean of the Columbia Business School in New York, the stakes are clear: "The question is whether the political process will make gradual changes or we'll wait for a crisis."

Contributing: Paul Overberg, Bruce Rosenstein

Elliot Wave's Futures Focus: Getting a Grip on Slippery Logic About Oil

Getting a Grip on Slippery Logic About Oil
10/1/2004 5:30:09 PM

Every day this week, headlines have explained the rise in Crude Oil prices with cause-and-effect logic that only seems plausible. Here's one from today:

Supply Worries Lift Oil Near $50 US (Toronto Star , October 1)

If this sounds right to you, it's probably because you've heard similar stories over and over. The fact is, explanations like this one are misleading, even if they do jibe with conventional wisdom. So what's the best alternative? Try turning this headline around:

Oil Near $50 US Lifts Supply Worries

Just by flipping a few words, the explanation changes completely… for the better. The prevailing perceptions about supply and demand tightness don't cause Crude Oil prices to surge. Rather, fluctuations in the price of Crude actually cause perceptions about Oil supplies to change.

Recent energy news provides more evidence of faulty logic. Citing supply disruptions due to weather, two oil companies solicited and received loans from the U.S. Strategic Petroleum Reserve (SPR) last week. Depending on what a barrel of Crude cost when the papers went to press, journalists reported the same fundamental "cause" as having two opposite effects.

When prices sagged on September 24, many headlines looked like this one:

Oil Dips as U.S. Loans Out Supplies (CNNMoney/Reuters )

But because Crude Oil finished higher that day and opened this week higher still, the news on September 27 offered a starkly different perception of SPR interventions. Here's an example:

"If anything, the market has taken the SPR loan as a bullish factor as it highlights how tight the market is in the U.S. Gulf, brokers said." ( Wall Street Journal Online)

These two stories contradict each other for a simple, yet striking reason: fundamentals like supply concerns don't drive prices, prices drive fundamentals. The news itself reflects what's already happened in the market -- in other words, it is a lagging indicator.

Wall Street Journal: China Is Joining Global Hunt for Oil And Coming Up Dry

China Is Joining Global Hunt for Oil And Coming Up Dry
By PATRICK BARTA
Staff Reporter of THE WALL STREET JOURNAL
September 23, 2004; Page C1

With oil prices still high, some see a new reason to think relief is on the way: China's oil companies are joining the global oil hunt, and they've got big money to burn. There's only one problem. They're not finding a lot of oil.

Instead, as China's oil giants fan out across the globe, they're learning what Big Oil has known for decades: Deep pockets don't always guarantee new discoveries, or even a stake in the world's premier oil fields. The best assets are either already controlled by the West, or they're off-limits to foreign investors – as in the Middle East. And China's oil companies don't have a lot of experience prospecting in hard-to-reach places.

As a result, some Chinese companies are settling for lower-return scraps the Western majors didn't want. In other cases, they're opting to spend on big natural-gas projects or refineries that don't bring more crude oil into the pipeline. The upshot is that China's majors are struggling to keep their reserves from dwindling at a time when their country -- and the world -- needs new oil more than ever. Rapid economic growth and declining domestic production are forcing China, a net oil exporter until the early 1990s, to now import 2.5 million barrels a day. That demand is placing a heavy strain on world supply and pushing prices higher. Unless China's oil companies find a lot more oil soon, Chinese imports are expected to more than double to nearly six million barrels a day by 2015, according to the East-West Center, a research center in Honolulu.

Many Western majors are holding the reins on new spending. But China's largest publicly traded oil and gas producer, PetroChina Co., is expected to invest $10.4 billion in new projects this year, compared with less than $7.5 billion three years ago, according to Deutsche Bank AG's global equity research staff. PetroChina's 2004 total is more than that of ChevronTexaco Corp. and all other large oil companies the bank tracked except for the U.K.'s BP PLC, Royal Dutch/Shell Group, France's Total SA and Exxon Mobil Corp. of the U.S.

Another major Chinese company, China Petroleum & Chemical Corp., or Sinopec, is expected to raise capital spending this year by 16% to $6.1 billion. Cnooc Ltd., China's primary offshore oil company, should boost investment by more than 40% this year to $2.2 billion, Deutsche Bank says.

All that cash is raising China's profile overseas, especially in places like Indonesia. In 2002, for example, Cnooc agreed to buy stakes in five Indonesian oil and gas fields from Spain's Repsol YPF SA for $585 million. That was followed by additional investments in other fields. PetroChina followed by paying $216 million for stakes owned by Devon Energy Corp. of the U.S. Chinese oil companies also have exploration and development projects under way in Venezuela, Canada, Thailand, Azerbaijan, Oman and the Sudan.

But while some of the overseas assets are large, many are in declining regions or are small oil producers by international standards. In some cases, China's companies have failed to get their hands on bigger, newer assets. In one example, Sinopec and Cnooc tried to secure a stake in an enormous field in Kazakhstan in 2003. But the other development partners exercised pre-emptive rights to block entry of the Chinese companies.

China's oil companies are thinking big, but "they haven't been involved in any finds that would make a dent in China's oil requirements," says Norman Valentine, an analyst at Wood Mackenzie, an energy consultant in Edinburgh, Scotland. Indeed, production from China's overseas investments is supplying only between 5% and 10% of its needed imports, says Kang Wu, a research fellow at the East-West Center. "I don't think that will rise," he says.

Even with all their spending, PetroChina and Sinopec both reported a drop in oil reserves last year. Cnooc's reserves have increased, but the company is much smaller, so those changes will have a much less measurable impact on China's needs.

China does have promising investments in the Sudan, where China National Petroleum Corp., PetroChina's state-owned parent, holds a 40% stake in a consortium that is developing sizable fields. But for now, the consortium is only producing about 300,000 barrels a day, with China getting a good deal less, analysts say. That is a drop in the bucket when the world is consuming more than 80 million barrels a day, and China more than six million.

CNPC said no one was available at the company for comment.

PetroChina and Sinopec didn't make executives available for an interview. But Mark Qiu, chief financial officer at Cnooc, says he is not surprised that China isn't securing more big fields overseas. Many proven assets are too expensive, he says, and operating in unfamiliar terrain is risky.

'Crisis looms due to weak dollar' by Dr. Jiang Ruiping published by the China Daily

Crisis looms due to weak dollar
Jiang Ruiping

Updated: 2004-09-28 08:42

Many international institutions and renowned scholars have recently warned that the possibility of a US dollar slump is increasing and may even lead to a new round of "US dollar crisis."

Since China holds huge amounts of US-dollar-denominated foreign exchange reserves, the authorities should consider taking prompt measures to ward off possible risks.

It is still too early to conclude if the US dollar is heading towards a crisis. But it is an indisputable fact that it has gone down continually. Its rate against the euro, for example, has dropped by 40 per cent since its peak period and it lost 20 per cent of its value against the euro last year alone.

It is becoming more and more evident that the possibility of a further slump of the US dollar is increasing.

From a domestic perspective, the worsening fiscal deficit will put great pressure on the stability of the US dollar.

In 2001 when the Bush administration was sworn in, the United States enjoyed a US$127.3 billion surplus. The large-scale tax cuts, economic cool-down, invasion of Iraq and anti-terrorism endeavours have abruptly turned the surplus into a US$459 billion deficit, which accounts for 3.8 per cent of the US gross domestic product (GDP).

By the 2004 fiscal year, the US Government's outstanding debt stood at US$7.586 trillion, accounting for 67.3 per cent of its GDP, which exceeds the internationally accepted warning limit.

The deteriorating current account deficit of the United States is another factor menacing the future fate of the dollar.

In recent years, the US policy that restricts exports of high-tech products, coupled with overly active domestic consumption and the oil trade deficit caused by rising oil prices, has deteriorated the US current account balance. This poses a great threat to a stable US dollar.

During the 1992-2001 period, the average US current account deficit was US$189.9 billion. In 2002 and 2003, however, the figure soared to US$473.9 billion and US$530.7 billion respectively. Experts predict that following its increasing imports in the wake of its economic recovery and continuing high oil prices, the United States will hardly see its current account balance improve.

Given the huge US current account deficit, the US dollar, if it is to remain relatively stable, must be backed up by an influx of foreign direct investment (FDI).

In 1998, 1999 and 2000, FDI that flowed into the United States was US$174.4 billion, US$283.4 billion and US$314 billion respectively. Starting from 2001, however, global direct investment began to shrink and US-oriented direct investment also decreased. In 2003, FDI into the United States was 44.9 per cent less than that in the previous year.

The decrease in FDI will put more pressure on the US dollar, which has been endangered by the huge US current account deficit.

Internationally, the Japanese Government's intervention in the foreign exchange market may become less frequent following the gradual recovery of the Japanese economy.

To deter the Japanese yen's appreciation and promote exports, the Japanese Government used to intervene in the foreign exchange market to keep the yen at a relatively low level. In 2003 alone, it put in 32.9 trillion yen (US$298.76 billion) to purchase the US dollar. The intervention constituted a major deterrent to US dollar devaluation.

As the Japanese economy fares better, the Japanese Government tends to back away from the market. Since April, it has not taken any steps to swing its foreign exchange market.

Another factor behind the risks of a US dollar slump is the weakened role of the so-called "oil dollar."

Given the deteriorating relations between the United States and the Arab world, quite a few Middle Eastern oil-exporting countries have begun to increase the proportion of the euro used in international settlement. Reportedly Russia is also going to follow suit.

If an "oil euro" is to play an ever increasing role in international trade, the US dollar will suffer.

In China's case, its rapidly increasing foreign exchange reserve will incur substantial losses if the US dollar continues to weaken.

At the end of 2000, China's foreign exchange reserve was US$165.6 billion. By the end of 2002, it rocketed to US$286.4 billion before it soared to US$403.3 billion by the end of 2003. By the end of June this year, the reserve was registered at a staggering US$470.6 billion.

About two thirds of the reserve is dominated by the US dollar. As the dollar goes down, China will suffer great financial losses.

Experts estimate that the recent US dollar devaluation has caused more than US$10 billion to be wiped from the foreign exchange reserve.

If the so-called US dollar crisis happens, China will suffer further loss.

The high concentration of China's foreign exchange reserve in US dollars may also incur losses and bring risks.

The low earning rate of US treasury bonds, which is only 2 per cent, much lower than investment in domestic projects, could cost China's capital dearly.
Due to high expectations of US treasury bonds, international investors used to eagerly purchase the bonds, which leads to bubbles in US treasury bond transactions. If the bubble bursts, China will suffer serious losses.

Moreover, since the Chinese trading regime requires its foreign trade enterprises to convert their foreign currencies into yuan, the more foreign exchange reserves China accumulates, the more yuan the Chinese authorities will need to put in the market. This will exert more pressure on the already serious inflation situation, making it harder for the central authorities to conduct macro-economic regulation.

Besides, investing most of its foreign exchange reserves in US treasury bonds also holds great political risks.

To ward off foreign exchange risks, China needs to readjust the current structure, increasing the proportion of the euro in its foreign exchange reserves.

Considering the improving Sino-Japanese trade relations, more Japanese yen may also become an option. During the January-June period this year, the proportion of China's trade volume with the United States, Japan and Europe to its total trade volume was 36.5 per cent, 28.6 per cent and 37.4 per cent respectively. Obviously, seen from the perspective of foreign trade relations, the US dollar makes up too large a proportion of China's foreign exchange reserves.

China could also encourage its enterprises to "go global" to weaken its dependence on US treasury bonds.

And using US assets to increase the strategic resource reserves, such as oil reserves, could be another alternative.

The author us director of the Department of International Economic under China Foreign Affairs University.

(China Daily)

World Bank's Wolfensohn: Ending poverty is the key to stability

Ending poverty is the key to stability
James D. Wolfensohn IHT
Wednesday, September 29, 2004
World Bank meeting

WASHINGTON The big issue of our time is global security. At present, we view it mostly through the lens of Baghdad or Beslan. While we certainly have to deal with these and other immediate concerns, we must not lose sight of the longer-term security issue that confronts us all. By far, the greatest potential source of instability on our planet today is poverty, and the hopelessness and despair that it brings to so many in our world.

Sixty years ago, the world recognized the need to bring hope to the millions of people left in shattered nations after World War II, and the World Bank was created to help them rebuild their lives. Its mission today remains as critical as it was then, if not more so.

It is in all our best interests to help countries that struggle with crushing poverty to take basic steps, such as getting boys and girls into school; preventing diseases like H.I.V./AIDS, malaria and diarrhea; protecting our forests and oceans; and removing obstacles to trade so that poor farmers can get their products to market.

Helping poor countries develop in this way is not merely the right thing to do ( though, of course, it is): 70 percent of U.S. export growth in recent years has been due to these emerging markets. Investing in development is the safe thing to do. It makes America and the world more secure to increase global economic and social stability and decrease frustrations that can lead to violence.

My generation did not grow up thinking this way. We thought there were two worlds - the haves and the have-nots - and that they were, for the most part, quite separate.

That was wrong then. It is even more wrong now. The wall that many of us imagined as separating the rich countries from the poor countries came down on Sept. 11, 2001. We are linked now in so many ways: by economics and trade, migration, environment, disease, drugs and conflict.

In our world of six billion people, one billion have 80 percent of the world's GDP, while the other five billion have the remaining 20 percent. Nearly half this world lives on less than $2 per day. One billion people have no access to clean water; over 100 million children never get the chance to go to school; and more than 40 million people in the developing countries are H.I.V.-positive, with little hope of receiving treatment.

Recent research suggests that a lack of economic opportunity, and the resulting competition for resources, lies at the root of most conflicts over the last 30 years, more than ethnic, political and ideological issues. This research supports the intuitive idea that if people have jobs, and if they have hope, they are less likely to turn to violence.

Over the next three decades, more than two billion people will be added to the planet's population, 97 percent of them in the poorer nations, and all too many will be born with the prospect of growing up into poverty and disillusioned with a world that they will view as inequitable and unjust. Instability is often bred in places where a rapidly increasing youth population sees hope as more of a taunt than a promise.

What must be done?

First, developing countries have to help themselves, particularly by tackling corruption more vigorously and focusing more on the basic needs of poor people. At the same time, the wealthier nations need to support them by offering more aid, by dismantling trade barriers, and by relieving the debt burdens of countries that are delivering on reform.

Between 1980 and 2001, the proportion of people living in poverty in the developing world fell by half, from 40 percent to 21 percent. Meanwhile, life expectancy in developing countries has increased by 20 years during the past few decades, while adult illiteracy has been halved to 25 percent. So we know that development aid can work. The challenge is to scale up the effort.

Improving stability in countries emerging from conflict, and in poor countries racked by hopelessness and frustration, is as important now as it was 60 years ago when the world was struggling to restore peace and rebuild the lives of millions. Stronger support globally for the fight against poverty is the best investment that can be made in building a more peaceful world and a safer future for our children.

James D. Wolfensohn, president of the World Bank, will be addressing the annual meeting of the IMF and World Bank Group this weekend.

Amartya Sen: An enduring insight into the purpose of prosperity

An enduring insight into the purpose of prosperity

By Amartya Sen
Published: September 21 2004 03:00

Friedrich Hayek's combative monograph The Road to Serfdom had a profound impact on political, economic and social thinking in the decades that followed its publication 60 years ago, serving as an intellectual manifesto against socialist planning and state intervention. But are Hayek's ideas and arguments of any interest today, after the downfall of communism and the emergence of neo-liberalism as the dominant ideology of contemporary capitalism? I would argue that they remain extremely important.

Consider Hayek's insistence that any institution, including the market, be judged by the extent to which it promotes human liberty and freedom. This is different from the more common praise of the market as a promoter of economic prosperity. A huge part of economic theory is concerned with the prosperity argument, going back to Adam Smith and David Ricardo. That connection is indeed important, and it is not surprising that so much attention has been devoted to seeing the market mechanism from this perspective - defending its achievements as well as disputing particular claims and proposing qualified endorsements. Yet Hayek was surely right to insist on clarity regarding the purpose of seeking prosperity. Markets have to be judged, he argued, by their role in advancing freedoms, not just in generating more income (as Hayek once said: making money can be of interest only to the miser). This integrative perspective demands that we be concerned both with the outcome of market processes (including the economic prosperity it may generate and the extent to which that would advance human freedom) and with the processes through which these results are brought about (including the liberty of action that people have in an institutional system).

It is the perspective of seeing markets and other institutions in terms of their role in advancing freedoms and liberties of individuals that Hayek brought into singular prominence. It may be pointed out, in contrast, that despite the title of Milton Friedman's famous book (with Rose Friedman), Free to Choose, the criteria by which Friedman tends to defend the market mechanism are not liberty and freedom, but prosperity and utility ("being free to choose" is seen as a good means - a fine instrument - rather than being valuable in itself). Even though a few other economists, James Buchanan in particular (and, to some extent, John Hicks), have presented insightful ideas on a freedom-centred line of reasoning, it is to Hayek we have to turn for the classic articulation of this way of seeing the merits of the market mechanism and what it gives to society. I am not persuaded that Hayek got the substantive connections entirely right. He was too captivated by the enabling effects of the market system on human freedoms and tended to downplay - though he never fully ignored - the lack of freedom for some that may result from a complete reliance on the market system, with its exclusions and imperfections, and the social effects of big disparities in the ownership of assets. But it would be hard to deny Hayek's immense contribution to our understanding of the importance of judging institutions by the criterion of freedom.

A second contribution of Hayek is of particular relevance to thinkers on the right of the political spectrum. In The Road to Serfdom, he gave powerful reason to indicate why explicit provision has to be made by the state and the society for the deprived and the dispossessed. While Hayek is often taken to be uncompromisingly hostile to any economic role of the state (other than what is needed to support the market mechanism), and certainly late in his life he gave grounds for thinking that this could indeed be his view, nevertheless in The Road to Serfdom Hayek's position is much broader and inclusive than that. Now that the welfare state is often under such attack, it is worth recollecting that the pioneering manifesto that championed the market mechanism on grounds of freedom did not reject the need for a welfare state and provided a reasoned defence of it as an institutional necessity.

A third contribution of Hayek is of particular interest to those on the left of the political spectrum. Hayek's critique of state planning is mainly based on a subtle psychological argument. He was particularly concerned with the way centralized state planning and the huge asymmetry of power that tends to accompany it may generate a psycho logy of indifference to individual liberty. As Hayek put it: "I have never accused the socialist parties of deliberately aiming at a totalitarian regime or even suspected that the leaders of the old socialist movements might ever show such inclination." One of Hayek's central points was that "socialism can be put into practice only by methods of which most socialists disapprove".

We can hardly ignore the massive accumulation of evidence - before and after publication of The Road to Serfdom - of tyrannical use of bureaucratic power and privilege, and the political and economic corruption that tends to go with it. Hayek's central point here was to note that even though socialism has a strongly ethical quality, that is not in itself adequate to guarantee that the results of trying to implement it will be in line with its ethics, rather than being deflected and debased by the psychology of power and the influence of administrative arbitrariness.

Hayek was insightful in drawing attention to a basic vulnerability that goes with unrestrained administrative authority, and in explaining why social psychology and institutional incentives are extraordinarily important. To take the massive evidence in socialist practice of departures from expected behaviour to be no more than easily avoided individual aberrations would be comparable to blaming the "few bad apples" to whom the leaders of the coalition forces point in Iraq when they refuse to consider the systematic corruptibility underlying the torture and brutality of an unrestrained system of imprisonment. Incidentally, Hayek's psychological insights into administration also tell us something about the genesis of those terrible contemporary events.

Our debt to Hayek is very substantial. He helped to establish a freedom- based approach of evaluation through which economic systems can be judged (no matter what substantive judgments we arrive at). He pointed to the importance of identifying those services that the state can perform well and has a social duty to undertake. Finally, he showed why administrative psychology and propensities to corruptibility have to be considered in determining how states can, or cannot, work and how the world can, or cannot, be run.

As someone whose economics (as well as politics) is very different from Hayek's, I would like to use the 60th anniversary of The Road to Serfdom to say how greatly indebted we are to his writings in general and to this book in particular. Dialectics is critically important for the pursuit of understanding, and Hayek made outstanding contributions to the dialectics of contemporary economics.

The writer, Lamont university professor at Harvard University, was awarded the Nobel prize for economics in 1998

September 29 Philippine Stock Market Daily Review: Profit taking Continues

September 29 Philippine Stock Market Daily Review

Profit taking Continues

If news confounds ordinary investors based on the causal relationships between events to market activities, particularly to that of record crude oil prices, yesterday and today’s contrasting demeanor of the financial markets in Wall Street and Asia is a perfect example. Yesterday, Bloomberg attributed New York’s decline, as well as Asia’s to High Oil price jitters, today, it seems that Energy issues represented by oil boosted most of the major bourses from its pathetic performances for the past sessions. According to Edgar Ortega of the Bloomberg, “Energy shares are the best performers among the S&P 500's 10 industry groups this year amid surging crude prices. The index of oil producers, drillers and refiners has jumped 24 percent in the period, compared with a decline of 0.2 percent in the S&P 500. Technology and consumer shares declined amid concern higher energy costs will crimp profit growth…An index of metal miners and chemicals producers in the S&P 500 climbed 2.2 percent, for the biggest gain among the benchmark's 24 industry groups.” So which is which, high oil prices hurts stocks or high oil provides better earnings for oil producers hence good for stocks? Go Figure.

Well the rising commodities seen in Oil, energy and metals have buoyed energy and mining issues in the US, Europe and in Asia. However, in the Philippines, the ‘no-brainer’ investment received a no-brainer response from the speculative proclivities of domestic investors mesmerized by hype and spin tall tales among the punter’s favorite issues. The Oil issues in fact, represented by its OIL index was sold down today (HAHAHAHAHA!!!) and is THE Largest Decliner among industry indices while the MINING index was hardly changed. Wow such incredible myopia!!!

The Phisix fell for the second session to close 3.99 points down or .23%. It looks as if the locals shifted their profit taking activities to some blue chips as Bank of the Philippine Islands (–1.08%) and Ayala Land (-3.07%), both of whom were supported by foreign buying, and San Miguel A. Meanwhile, Ayala Corp was the sole blue chip expended by foreign money as the Ayala parent firm dropped 1.63%.

Foreign money remained bullish and in control of the market commanding about 56.39% of today’s turnover with a net positive inflow to the market amounting to P 150.467 million or about 19% of the day’s output with most of these inflows directed to SM Primeholdings (unchanged). On the broad market, foreign capital acquired 11 more issues than it sold meaning the foreign investors were still bullish, acquiring stocks on most blue chips as well as in the broad market. Although, the general sentiment as reflected by the advance decline differentials remained in favor of the bears, by 42 to 28 while industry indices were mostly down except for the Mining and Commercial Industrial, largely lifted by Globe Telecoms up 1.88%. The second tier issues of the Phisix or our punter’s favorites, namely Metro Pacific (+3.7%%), Digitel (+4.81%), DM Consunji (+1.94%) and Filinvest Land (+1.73%), cushioned the drop of the Phisix indicative of an easing profit taking moves by local investors.

Going into the last trading session of the week as well as the last trading days of the month we may expect some action to pick up as local investors seemed to have eased on selling (and may reverse) while foreign money continues to support the market.

Helen Pridham of the Timesonline: Oil your chance to strike it rich?

Oil: your chance to strike it rich?

By Helen Pridham, Personal Finance correspondent

As the price of crude oil scales new heights, topping $50 a barrel for the first time in New York on Monday night, the immediate cause of the price surge might be different - this time attributed to violence and uncertainty in Nigeria and around the west African oil fields - but the fundamental reason remains the growing imbalance between supply and demand.

The same situation exists in other commodities such as base metals. All this is good news for the natural resources sector, which has performed strongly over the past year.

Future prospects for the sector continue to look extremely promising according to Ian Henderson, the manager of JPMorgan Fleming Natural Resources fund, who says, "We believe we are very early in a multi-year bull market for commodities."

The background to this is many years of underinvestment in mining and exploration coinciding with growing worldwide demand for natural resources, particularly from China, India, and other developing countries.

Even though economic growth in China is expected to slow from more than 10 per cent to around 7 per cent in the next couple of years, this rate of growth is still extremely high by western standards and will still mean a strong demand for commodities and therefore lead to continuing price rises. For instance, oil demand in China is expected to rise by a further 8 per cent next year, reaching 500,000 barrels per day.

Robin Batchelor, an investment manager on the Merrill Lynch World Mining Trust says, "What you see in China is structural change. China wants consumer growth and this means changing patterns of behaviour which is leading to greater and greater demand for energy and raw materials.

For investors, getting a stake in this area provides useful diversification as well as the prospect of attractive returns, says Henry Rising, the head of research at stockbrokers Christows. "We believe you have to look beyond ordinary equities nowadays for returns. With resources there is a real growth story, especially if you look at the industrialisation of China."

This view is echoed by Mick Gilligan, an associate director in fund research at the stockbrokers Killik & Co. "The supply and demand backdrop for energy and commodities is very encouraging. They look quite exciting areas at the moment and not ones you want to be underweight."

A gradual decline in investment in mining and exploration in the last 20 years has lead to a real shortage in commodity stocks. Ian Henderson points out that the stocks of base metals above ground have almost run out. "There has been a complete miscalculation of demand because it was based just on demand from the OECD countries, which only accounts around one-seventh of the world's consumers. Now China has become the biggest importer of everything. Many of the things it was previously exporting, such as coal, oil, steel and zinc, it is now importing to meet its own consumption."

He is surprised that more investors are not taking notice of the sector, especially as there are still plenty of companies on good valuations. "One example is First Quantum, a copper mining company which operates in Zambia which will be producing more than 5 per cent of the world's copper in a year's time. It is on a profits to earnings ratio of less than seven, yet it has tremendous prospects."

Energy is a key investment area for resources funds. Mr Henderson believes there is an "incredible complacency about energy". He says that people who are expecting the oil price to fall back again will have a rude awakening. This year has seen the biggest increase in the demand for oil in history. China alone has upped its demand by 20 per cent over the past year.

Unlike the oil crisis in the 1970s, which was brought about artificially by Opec, this time there have been increases in production by the oil producers' cartel, yet the price of oil has continued to rise. While production in areas such as the North Sea and Alaska are declining in output and traditional oil producing giants such as Saudi Arabia and other Opec states fail to influence the global oil price, it is variations in supplies from Russia, Venezuela and Iraq which has impacted the world oil market, where underinvestment in refinery capabilities - especially in the United States - has had a greater impact on prices.

Mr Batchelor says that the best way to benefit from these trends is through small and medium-sized exploration companies, rather than traditional oil giants such as BP or Shell, where growth potential is limited. The example of Cairn, the Scotland-based company which has seen its share price rise more than 300 per cent this year on the back of exploration finds in India, is the prime example.

Companies operating in relatively underdeveloped areas, such as north and west Africa, can add particular value, says Mr Batchelor.

Coal is another area which Mr Henderson finds interesting at present. "In North America, 52 per cent of energy production comes from coal and most new power stations are coal-fired, but here too there is a shortage of supply."

The shortage of traditional energy supplies is stimulating greater interest in alternative energy. Mr Batchelor, who is also the lead manager on the Merrill Lynch New Energy Technology investment trust, says, "There are signs that things are moving in the right direction. The cost of wind turbines, for example, is falling while the price of coal and natural gas is rising, so traditional energy is getting more expensive while new energy is getting cheaper."

Renewable energy is now the fastest growing part of the energy market but Mr Batchelor admits that the scale is very different to traditional energy suppliers. "It takes time to change people's behaviour patterns but I think as more companies look at their cost base and the price of energy, they will turn increasingly to alternative energy. It won't happen overnight but it will happen slowly but surely over the next few years. In the energy sector, it really is a case of past performance being no guide to the future."

Mr Gilligan agrees. "At some point, alternative energy will be a good investment but it will be difficult to get the timing right. This is probably a classic case in favour of a regular monthly investment in order to ride out the volatility in this market."

The main risk for the energy and resources sector at present is the possibility of a sharp slowdown in global growth, but Mr Henderson points out that the on-going industrialisation of emerging markets will continue to underpin the market. "There may be wobbles along the way, but basically I think the process is unstoppable."

Financial Times: Forex trading volumes hit record levels

Forex trading volumes hit record levels

By Jennifer Hughes and Krishna Guha

Published: September 28 2004 15:59

Last updated: September 28 2004 19:53

Trading on the world's foreign exchange markets has leapt to a record $1,900bn a day, driven by renewed interest in currencies as an asset class and the return of hedge funds specialising in currency bets.

Turnover in currency and interest rate derivatives sold by banks also soared to new record levels, according to a three-yearly survey by the Bank for International Settlements.

The rapid growth in financial market transactions - far in excess of the growth in world trade - is a sign of growing integration of global capital markets and increasingly sophisticated risk management by companies and investors.

After slumping amid the introduction of the euro, which eliminated the currencies of some of the world's biggest economies, trade in foreign exchange bounced back between 2001 and 2004.

The BIS said investors disappointed by equity returns and low bond yields were searching out new forms of investment, including currencies.

Macro hedge funds - specialising in big currency bets - were back in business after having been eclipsed by funds betting on equities.

Growing activity in Japanese interest rate options signalled that the Japanese economy was stirring back to life.

But key features of the market have endured. The dollar rules supreme as the world's dominant currency, involved in 89 per cent of all currency trades. London retains its position as the world's capital for foreign exchange trading, with a stable market share of 31 per cent.

The last BIS survey in 2001 had shown daily volume of $1,200bn, equivalent to almost $1,400bn at today's exchange rates.

Trading in derivatives, including currency options, interest rate swaps and forward rate agreements, leapt by 76 per cent to $1,200bn a day, the BIS said, based on constant exchange rates.

Volumes were well above what market watchers expected. Many predicted volumes would have risen to about $1,500bn as a result of growing interest in the market and the strong trends produced by the dollar's decline.

The BIS report is considered the most authoritative on the currencies markets, which trade round the clock and across borders every day of the week.

The jump in trading volumes underlined the status of foreign exchange as the biggest single market in the world.

The report cited "investors' interest in foreign exchange as an asset class alternative to equity and fixed income, the more active role of asset managers and the growing importance of hedge funds" as reasons behind the growth of the market.

Ian Stannard, currency strategist at BNP Paribas in London, said: "We're seeing a lot more participation by investor groups who haven't actively managed currency risk before. FX [foreign exchange] is being seen more as an asset class in its own right."

The weakening of the dollar against other currencies over the past two years has provided a strong trend which has drawn new players into actively dealing in currencies.

Many investment banks attributed part of the strength of their trading profits last year to the moves in foreign exchange.

Reuters: Argentina cenbank ups gold reserves to 55.1 tonnes

UPDATE 1-Argentina cenbank ups gold reserves to 55.1 tonnes
Tue Sep 28, 2004 05:47 AM ET

LONDON, Sept 28 (Reuters) - Argentina's central bank bought more gold in July and August, taking its gold reserves up to 1.77 million troy ounces by the end of August, or 55.1 tonnes, according to data on the bank's website.

The bank confirmed in August that it had bought 42 tonnes of gold in the first half of 2004 to diversify its reserves after the end of the peso's one-to-one peg against the dollar in early 2002.

The bank's website showed that gold reserves were at 1.72 million ounces (53.5 tonnes) in July and 1.37 million ounces (42.6 tonnes) in June.

Spot gold was trading at $410.25/411.00 by 0941 GMT, compared with $408.70/409.50 late in New York on Monday.

Dow Jones UK PRESS: Pressure Grows On G7 To Agree US Dollar Devaluation

DJ UK PRESS: Pressure Grows On G7 To Agree US Dollar Devaluation

09/26/2004Dow Jones News Services
(Copyright © 2004 Dow Jones & Company, Inc.)

LONDON (Dow Jones)--U.S. President George Bush is being urged to signal a dollar devaluation of up to 20% to rebalance the global economy ahead of Friday's Group of Seven and International Monetary Fund meetings in Washington, the U.K.'s The Business newspaper reported.

Senior U.S. administration officials in Washington have over the past few days tried to influence the White House and U.S. Treasury to put pressure on the G7 to agree to a dollar depreciation in its final statement, the newspaper said.

Recent data have shown the U.S. current account and trade deficits running at record levels, and economists have said a dollar depreciation is needed to rein these in.

The euro was quoted at $1.2260 in late New York trade Friday, compared with $1.2273 on Thursday. The dollar was fetching Y110.64 versus Y110.63, and CHF1.2624 versus CHF1.2598. The pound was trading at $1.8041, up from $1.7982.

The G7 will also call on the world's oil producers to take further action to bring down prices, The Sunday Times reported. Crude oil reached almost $49 a barrel in New York Friday, amid continued concerns that high energy costs will sap global growth.

Spurring economic growth will be high on the agenda at the meetings of G7 finance ministers and central bankers next week, U.S. Treasury Secretary John Snow said Friday.

"The promotion of economic freedom, opportunity and growth throughout the world will be a key topic," he said in a statement in New York City.

G7 officials meeting in Washington next week will be representing Canada, Italy, France, Germany, Japan, the U.K. and the U.S. Officials from China will also be present.

-By Neil Keane; Dow Jones Newswires; +44-20-7842-9495;

(END) Dow Jones Newswires
09-26-04 0623ET

September 28 Philippine Stock Market Daily Review: Locals Panic

September 28 Philippine Stock Market Daily Review

Locals Panic

The Phisix tumbled during the later portion of the trading session to close 14.25 points lower or down by .81%, alongside the majority of the Asia’s bourses. Bloomberg’s Michael Tsang attributes the fall to concerns of rising oil prices, “Asian stocks fell after oil surged to above $50 a barrel, raising concern higher fuel costs will stifle economic and earnings growth…Crude oil for November delivery rose as high as $50.35 a barrel in after-hours electronic trading on the New York Mercantile Exchange and was recently at $50.32. Futures haven't been at those levels since they started trading in 1983. Oil prices climbed 36 percent this quarter.”

Well dissecting the domestic market we find that foreign money remained upbeat with local issues accumulating P 107.060 million (US$ 1.898 million) worth of assets representing about 14.2% of today’s output while they likewise accounted for a slight majority or 53% of today’s activities. In addition, overseas investors bought 10 more issues than they sold in the broader market indicative of their upbeat outlook with Philippine equity assets. Furthermore, among the blue chip issues only Ayala Corp (-3.17%) took the brunt of the foreign selling together with minor outflows seen in Globe Telecoms (-3.19%). Coincidentally, these two heavyweights weighed on the Index while the rest of the field posted inflows from overseas money and were largely unchanged (PLDT, ALI, SMCB and SMPH) except for BPI who defied the bearish sentiment and rose by 1.09%.

While the blue chips were slightly affected by the late day sell off we note that declining issues led advancing issues by 56 to 19 or almost 3 to 1. Aside, industry indices were mixed with three decliners led by the All (-1.28%) index, Commercial Industrial (-1.07%) and the Property (-.84%) Index while three recorded advances OIL (+1.88%), Financial (+.53%) and Mining (+.21%). All these shows that the locals whom were unusually cautious since last week took these negative developments (cascading peso, surging oil prices, regional decline, et. al.) as possible trigger to the profit taking activities seen today even as foreign money continued to amass on the blue chips and other select issues. And the sharp declines of the recent local punter’s favorites, namely MPC (-6.9%), Digitel (-5.68%), Filinvest Land (-5.08%), DM Consunji (-3.73%), Union Cement (-5.55%), Empire East (-8.33%) et. al., simply attest to these developments.

Relative to the technical picture, the latest failed attempt to breach the resistance barrier of the 1,770’s levels could in the interim signal a bearish top or a ‘double top’ formation which means that the Phisix could fall further in the coming sessions, although today’s activities can be hardly be seen as such yet, given its premature phase. A breakdown from the 1,693 support level would in effect be confirming this bearish formation.

So far foreign money has provided the support to our market even as the fickle local investors found their catalysts to take profits. It remains to be seen if today’s sell off would be carried over in the following sessions and if it would affect the outlook of the broad market. However, the fundamentals for foreign money (easy money landscape, global liquidity and less correlation to the US markets) to invest in emerging market remains while the market’s historical patterns, cyclical shifts, seasonal strength and technical picture still points to a year end rebound.

New York Times: Japan set to label China as war threat

Japan set to label China as war threat
James Brooke

NYT ~~article_owner~~ Wednesday,

September 15, 2004

Koizumi advisers reportedly urging a shift in strategy

TOKYO Reflecting growing wariness between the two giants of Asia, an advisory panel to Japan's prime minister will recommend that China be viewed as a potential military threat for the first time, a newspaper here reported Wednesday.

Since the end of World War II, Japan has regarded its main military threat as coming from the north, Russia, and from the west, North Korea. But now, according to the report in Japan's leading business newspaper, Nihon Keizai, the 10-member advisory panel to Prime Minister Junichiro Koizumi will recommend that China, its neighbor to the southwest, be regarded as a potential military threat.

Although China has about 10 times the population of Japan, its traditional dominance of Asia was in remission during the 20th century as it was hobbled first by civil war and Japanese military rule, then by half a century of communist economic policies.

With the recent market-oriented economic boom, China's economy is expected to surpass that of Japan in 15 years. Already it is investing heavily in military spending.

“While the Russian military capability in the Far East has dropped dramatically in the last 15 years, conversely, China has gone on a big spending boom,” Lance Gatling, an American aerospace and defense consultant, said in an interview Wednesday. “They are looking at a deep-water navy, more offensive weapons, reconnaissance satellites.“The panel will not call it directly a military threat, but the concern about a conflict between Taiwan and China is quite real, and Japan is concerned about getting drawn into that.”

Japanese and American officials have held discussions this week about the possibility of permitting U.S. and Japanese military flights to an island with a civilian landing strip that is almost halfway between Okinawa and Taiwan. According to a Washington-based defense expert visiting Tokyo, Japan is considering the request, along with a proposal to build a port on the island, Shimoji Shima, that would be able to berth Japanese ships equipped with antimissile batteries. In recent years, Japan has used the missile and nuclear program of North Korea as public justification for its growing partnership with the United States in developing a missile defense. This has allowed Japanese military planners to avoid talking about China, one of the world's five major nuclear powers.

Japanese officials hope to avoid getting drawn into any conflict between China and Taiwan, a former Japanese colony that Beijing regards as a breakaway province. However, the East China Sea is seeing a rise in direct tensions between China and Japan.Boatloads of Chinese nationalist groups, allegedly privately financed, have tried to land this year on the Senkakus, about 160 kilometers, or 100 miles, northwest of Shimoji Shima. This uninhabited archipelago is claimed by both nations.

In addition, China has started laying a gas line across the seabed toward an area that Japan claims as its exclusive economic zone. While the Chinese drill for gas, a Japanese survey boat is conducting its own research.

“Since China is deploying military vessels, there are people saying this is a matter for our Self-Defense Forces, and I am really worried,” Yukio Okamoto, a former prime ministerial aide for Okinawa, said in an interview, referring to the Japanese armed forces.

While military tensions appear to be on the rise, booming trade with China is credited with pushing much of Japan's current economic recovery.

With Toyota recently announcing a $500 million investment in China, China is expected to displace the United States this year as Japan's top trading partner.

However, this economic bonanza could be threatened by widespread anti-Japanese sentiment in China and by Koizumi's visits to Yasukuni, a Shinto shrine to Japan's war dead.

“Toyota is worried about a Chinese boycott,” an aide to Koizumi said Wednesday. Referring to heavy pressure by Japanese businesses on Koizumi to improve relations with China, he said: “Japan is starting to lose contracts.”

The New York Times

Economist: This is not America

This is not America
Sep 24th 2004 From The Economist Global Agenda

As the Federal Reserve continues to tighten America’s monetary policy, will central banks in East Asia follow suit?

AMERICAN interest rates exert a gravitational pull over global capital, which emerging markets find hard to escape. When interest rates are low in America, investors flock to emerging markets in search of higher yields. But when the Fed nudges rates up, as it did for the third time in three months on Tuesday September 21st, the flow of capital to emerging markets normally ebbs, forcing their central banks to raise interest rates if their currencies are not to fall.

But in this tightening cycle, the emerging markets of East Asia are enjoying some unaccustomed room for manoeuvre. The “automatic” link between their rates and American rates is slipping, argues Julian Jessop of Capital Economics, a consultancy. Hong Kong, which maintains a hard peg to the dollar (backed by a currency board), will have to raise rates, but South Korea has already cut them once this year and may do so again (see chart). Taiwan may raise rates by a quarter of a percentage point, but seems in no great hurry. Meanwhile, the monetary authorities in China, the most closely watched emerging market of all, seem determined not to be rushed into anything.

East Asian currencies are certainly under pressure at the moment. But the pressure is upward. This has yet to show up in their exchange rates. The Malaysian, Chinese and Hong Kong pegs to the dollar have held firm. The Singaporean and Taiwanese dollars have strengthened slightly against the American variety in the past year, as has the South Korean won, but the monetary authorities in each of these countries have resisted any strong upward movements in their currencies.

Suppressed in the currency market, this pressure to appreciate shows up instead in the current-account surpluses these economies run and the mountain of dollar reserves they have amassed. Their combined current-account surplus amounted to well over $100 billion last year and their hoard of reserves is currently worth about $1.2 trillion.

In short, East Asia is becoming a region of dollar creditors, not dollar debtors. Singapore, Taiwan and China have long enjoyed this position; South Korea and Malaysia, however, were chronic borrowers until their financial crises in 1998. Since then, they have embraced the virtues of thrift, saving more than they invest each year, and parking the excess in copper-bottomed dollar assets.

The Chinese authorities alone now hold $483 billion in reserves, much of it in American Treasury bonds. They will meet the man who has written all those IOUs next week in Washington, when, for the first time, Chinese officials will be invited to join John Snow, America’s treasury secretary, and the other finance ministers from the G7 group of rich nations, at one of their annual summits.

The meeting will be tense, because America is a remarkably ungrateful debtor. Instead of thanking China for buying its assets, it denounces it for not buying enough of its goods. It complains that China’s exporters are stealing a march on its own manufacturers and demands that the Chinese revalue the yuan to dull their competitive edge. Mr Snow will repeat this call next week, urging the Chinese to introduce more “flexibility” in their exchange-rate arrangements. A truly flexible exchange rate can move either way, of course. Mr Snow only cares that China’s moves up.

China faces a dilemma common to all the dollar creditors in the region, argues Ronald McKinnon of Stanford University. If they let the dollar fall against their currencies, they would suffer a capital loss on their holdings of dollar assets. A cheaper, more competitive dollar is a boon to the American manufacturer, but a bane to the holder of dollar assets. Indeed, the very fear of such a capital loss can bring it about, if it prompts private holders of dollars to flee from the greenback into the domestic currency. In East Asia, emerging markets have almost as much to fear from a run into their currencies as from a run on them.

In China, despite its thicket of capital controls, speculators have already placed bets on a revaluation of the yuan. The authorities have kept a peg of 8.28 to the dollar since 1994. But though the yuan’s value abroad has remained rock-steady, its value at home has slipped. Inflation is now running at 5.3% per annum. In the past, the People’s Bank of China has talked about raising interest rates if inflation crossed the “bearable limit” of 5% (real rates—ie, adjusted for inflation—are now zero). But to do so would invite further speculative flows into the yuan.

Which brings us back to the Fed. As it raises interest rates, American assets will yield better returns. This will encourage holders of these assets to keep them, rather than dumping them in favour of yuan, won or ringgit. Thus, a tighter monetary policy in America will relieve some of the upward pressure on the currencies of East Asia. In the months ahead, the monetary authorities of emerging markets will be watching the Fed as closely as ever. But this time they may not scurry to follow its lead.

Financial Times: Global economic expansion fuels rebound in foreign direct investment

Global economic expansion fuels rebound in foreign direct investment

By Frances Williams in Geneva

Foreign direct investment is on the rebound this year after three years of steep decline fuelled by global economic expansion and rising company profitability, the United Nations said yesterday.

In its annual world investment report, the UN Conference on Trade and Development (Unctad) also said services offshoring was still in its infancy but was fast approaching a "tipping point" that could see a dramatic takeoff in the relocation of services jobs to lower-cost countries.

However, adopting measures to force service jobs to stay at home would be shortsighted, Unctad said. Protectionist measures were likely to destroy rather than save jobs in the longer run.

Inflows of foreign direct investment (FDI) fell by 18 per cent last year to $560bn (€454bn, £311bn) less than half the 2000 peak of $1,400bn, said the report.

The drop mirrored a 20 per cent decline in the value of cross-border mergers and acquisitions, which have emerged as the key driver of FDI, especially in the industrialised world, since the late 1980s.

While FDI inflows to rich nations slumped 25 per cent last year, inflows to developing countries rose 9 per cent to $172bn in 2003 from $158bn in 2002. Nearly two-thirds of this went to the Asia-Pacific region, with China accounting for $54bn, slightly more than in 2002.

China became the largest recipient of FDI inflows last year (not counting "transhipped" investment through Luxembourg) as flows to the US halved to $30bn, the lowest level since 1992. Germany and the UK also recorded much lower inflows than in 2002.

However, FDI outflows from rich countries rose modestly last year. Together with the improved economic climate and increased cross-border mergers activity, "that suggests that a recovery is under way in 2004", said Carlos Fortin, officer-in-charge of Unctad.

Though inflows and outflows should balance, in practice they diverge because of differences in collection methods, coverage and so on. Statistics are also subject to revision. Thus China was reported as overtaking the US in FDI inflows in 2002, whereas the latest data suggest the US was then still ahead before falling behind last year.

The services sector now accounts for two-thirds of FDI flows and about 60 per cent of the existing FDI stock, from less than 50 per cent a decade earlier.

The most far-reaching changes were taking place in services that can be supplied from abroad using information technology. While researchers have estimated that 2m-5m services jobs could shift offshore over the next five to 10 years, the numbers could be far greater, Unctad said.

"Most multinationals haven't even started offshoring," said James Zahn, an Unctad economist. "What we're seeing may just be the tip of the iceberg."

Ireland, Canada, Israel and India account for more than 70 per cent of the total market for offshored services. www.unctad.org/wir

EmergingPortfolio.com: Investors fuel up EM and developed market equity funds

Investors fuel up EM and developed market equity funds

Investors pumped a net $1.52 billion into developed and emerging markets equity funds tracked by EmergingPortfolio.com Fund Research (EPFR) in the week ending September 15. Rising share prices globally, lower oil prices and solid economic data that was not too strong as to spark worries of rapid monetary tightening helped to encourage investors back into equity funds after six straight weeks of outflows. And the continuing rally in emerging markets debt helped the Emerging Market Bond Funds to their sixth straight week of net inflows.

EPFR tracks equity funds with $1.06 trillion in assets on a weekly basis and fixed income funds with assets of $97 billion. The firm collects flows and allocations data directly from about 7,000 funds with $3 trillion in assets registered in the world’s major fund domiciles, including the US, Luxembourg, Ireland, UK, Caymans, Guernsey, etc. As a result, EPFR’s asset coverage of international developed and emerging market fund groups is the largest and most diverse among fund trackers and more accurately represents global institutional investor sentiment.
Equity Fund Flows*Cumulative 2004 net fund flows by fund category to Sept 15

The combined Emerging Market Equity Funds tracked by EPFR with $106.6 billion of total assets received $349.2 million of fresh money. And even the diversified Global Emerging Markets (GEM) Funds enjoyed inflows for the first time since the week ending July 7. These funds took in $109 million from investors, reducing their year to date outflows to $5.38 billion. Asia ex-Japan Equity Funds enjoyed their fourth straight solid week of interest from capital sources by taking in an additional $154.8 million. These funds have received $528.7 million in the last four weeks, increasing YTD total net inflows to $3.3 billion, or nearly 13% of their beginning of year total assets. Latin America Equity Funds have received net inflows for five straight weeks and the week’s $20.2 million of inflows gives the fund group net inflows of $5.6 million so far this year while EMEA Equity Funds have received inflows for seven weeks running and are the flows leader among EM equity funds in percentage terms: the $1.6 billion of YTD inflows amounts to 19.6% of their total assets.

The runaway fund group leader in terms of total value of inflows are the Global/International Equity Funds. The 1,150 funds tracked by EPFR with $246.7 billion of assets have absorbed $11.2 billion of new money so far this year, representing a little more than 5% of their total assets at the beginning of 2004.

The YTD leaders in percentage terms are the Japan Equity Funds, with net inflows of a whopping $8.87 billion, or 54.4% of their beginning of year total assets. These 205 funds with $27.8 billion in assets tracked weekly by EPFR saw outflows of $39 million in the latest week. It was a modest loss considering the previous week these funds took in $325 million of new money.

US Equity Funds received net inflows for the first time in seven weeks, taking in $847.3 million of net investor contributions during the week. EPFR tracks 2,150 US Equity Funds with $609 billion in assets on a weekly basis. YTD these funds have taken in only $902 million of net inflows.

As European share prices have hit 10-week highs and the euro has held its ground against the dollar, investors have seen fit to squirrel away some money into the Europe Equity Funds for two consecutive weeks. These funds took in $109.2 million in the latest week but have had outflows of $838.5 million year to date.

A surge in the supply of emerging markets debt during early September did nothing to depress the appetite of investors for this asset class. The 249 dedicated Emerging Markets Bond Funds tracked by EPFR posted net inflows for the sixth straight week as nearly $2.4 billion worth of new issues from Brazil, Turkey and the Philippines hit global markets.

For the week ending September 15 the EPFR-tracked EM bond funds - which currently have $17 billion worth of assets under management - took in $33 million. Since August 5 these funds have pulled in a net $322 million and inflows on a year to date basis stand at $516.9 million.

Furthermore, strong demand for the higher quality debt that these funds rotated into during April and May was reflected in their portfolios, which posted a collective gain for the seventh straight week. During that run the value of the fund’s collective portfolios has climbed by $690 million.

Emerging markets debt continues to benefit for the current perception that US interest rates, and hence the return on safer US debt instruments, will not rise rapidly in the foreseeable future. As a result, investors have shifted their attention back to the higher yields available in the emerging markets.

Improving fundamentals in key markets, confirmed by a slew of ratings upgrades, has made it easier for investors to swallow the risk that comes with this asset class. Venezuela and Brazil are the latest countries to have their credit ratings upgraded. Russia aside, the recent political, policy and macroeconomic news has been supportive. Brazil (strong GDP growth), Turkey (efforts to converge on EU membership), Venezuela (post-referendum stability) and India (better than expected 2004-05 budget) have all contributed to the generally positive sentiment.Finally, Global Bond Funds tracked by EPFR posted net inflows of $143.7 million, their seventh straight week of net investor contributions. These 252 funds with $81 billion in assets have enjoyed net inflows of $3.58 billion so far this year, amounting for 4.9% of their total assets.

September 23 Philippine Stock Market Daily Review: Low Interest Landscape Fuels Foreign Buying

September 23 Philippine Stock Market Daily Review

Low Interest Landscape Fuels Foreign Buying

Oops, while yesterday’s chart formation and market internals emitted negative signals leading this analyst to forecast a possible retracement today, apparently foreign money anteed up on their holdings of local equity assets even as Wall Street succumbed to a sharp decline last night. This underscores the folly of short term forecasting.

In the past newsletters we have noted of two salient factors that may lead foreign money’s attraction to Philippine Equity assets; first the low interest rate environment. Yesterday marked another threshold low for US 10 year note, from Bloomberg “U.S. Treasuries rose, pushing the yield on the 10-year note below 4 percent for the first time since April”. Despite the US Fed’s reserve third rate hike this year, the rally in governments bond prices globally signal the imminent top of the rate increases. Hence the proclivity of international fund managers to eye on markets with high-risk high-yield potentials and with low correlation to the US markets. Second, the disconnect with the US financial markets, today’s fierce rally in spite of Wall’s Street’s morose outlook in its equity markets simply highlights the Philippine Market’s independence from the major global bourses. As of the moment, the Phisix is one of the minority gainers among the Asian bourses, including Pakistan and China’s Shanghai. While one day does not make a trend the recent gamut of divergences has slowly been molding.

Foreign money controlled trading activities that accounted for 56.79% of the today’s aggregate output and soaked up on the local equities assets to the tune of P 132.257 million. Naturally, the concentration of the sprightly accumulations were on the blue chips. Of the 8 major cap issues 6 posted capital fluxes from overseas investors with the meat going to the Property heavyweights, SM Primeholdings (+1.61%), and Ayala Land (+1.56%). PLDT (+3.0%), which had been sold down for the past three sessions by portfolio money, posted a reversal and is the third largest recipient from investors abroad. Only Globe Telecoms (-1.38%) and Ayala Corp (unchanged) registered negligible outflows. Obviously, the correction in Globe Telecoms was more than offset by the gains of PLDT. PLDT together with the key property heavyweights and San Miguel B (+1.43%) also on foreign buying buoyed the Phisix by 14.68 points or .85% for the fourth straight session. The rest of the field except for Globe Telecoms were neutral for the day.

Market breadth showed the bulls ahead of the bears by a slim margin 33 to 30. Moreover, industry indices were tilted towards the bears as declining indices (Banking and Finance, Mining and the ALL index) edged out advancing indices (Commercial Industrial and Property) by 3-2 with the Oil index unchanged. However, foreign money bought more issues than it sold in the broadmarket.

The figures above tells us that:

First foreign portfolio money are manifestly are becoming more bullish.

Second, the locals, whom have evidently slowed on their rotational buying binges in the general market, has limited their actions to a few issues and sold the broadermarket hence the tight advance decline differentials. Today’s darling is Gokongwei’s Digitel (+13.43%) the only major telco player whose share prices have lagged its contemporaries for over a year.

Lastly, in spite of all of the headline ‘fire and brimstone’ outlook on the local economy, the Phisix has managed to outperform major market as the US. Could this be a sign that investors have discounted the Philippine economic conundrum or does it show that the seemingly flagging US economy is in a more critical condition than ours, hence the aggressive inflow?

"Economic death" for the Philippines in two years without new taxes: Arroyo

"Economic death" for the Philippines in two years without new taxes: Arroyo

MANILA, (AFP) - President Gloria Arroyo warned that the Philippines risked a "painful economic death" within two years unless taxes are raised to avert a feared debt default.

In a statement printed in the Philippine Star newspaper, she urged the country to "suffer the pain now and experience the gains two years hence (rather) than postpone the pain and die a painful economic death two years from now."

Popular opposition is posing a key stumbling block to Arroyo's bid to balance the national budget through increased taxes.

The eight-month budget deficit rose to 111.1 billion pesos (1.98 billion dollars) in August, compared to the full-year ceiling of 198 billion pesos or 4.2 percent of the gross domestic product (GDP), the finance department said Tuesday.

On Monday Fitch Ratings warned Manila of a potential sovereign credit downgrade if no tax measures were passed by year's end. Manila's government securities are now two notches below investment grade.

"The government cannot subsist on borrowed funds all the time ... (because) the interest payments will catch up with us," Arroyo said.

"If we remain in denial and refuse to take our situation seriously, the world may just impose the truth upon us. When that time comes, the Philippines would be the financial pariah of the world."

A survey by Manila-based Pulse Asia polling organisation last week found that 78 percent of Filipinos "see no need to impose new taxes as long as the government strengthens its tax collection efforts."

Arroyo said the government needed 180 billion pesos more in annual revenues to ease the burden on government debt, which she said stood at 71 percent of GDP -- the third highest in Asia.

She has asked Congress to pass a series of tax laws that would raise at least 80 billion pesos a year.

House of Representatives Speaker Jose de Venecia warned last week, however, that his colleagues were likely to pass only four bills this year and that the extra income would be up to 60 billion pesos short of the target.

Bear, Stearns and Co. analyst John Stuermer said recent sovereign issues by the Philippines showed it "still has fluid access to the capital markets and that press comments comparing the Philippines with Argentina are grossly exaggerated."

However, "the persistence of a budget deficit in a range of 4.0-5.0 percent of GDP is steadily raising the overall public sector debt burden and will make public debt management an increasingly difficult task without more meaningful fiscal reform."

Stuermer predicted that Arroyo would have a hard time getting reform measures passed by Congress despite winning a fresh mandate in the May presidential elections.

He also criticized her government for its reluctance to discuss its borrowing requirements "on a total public-sector basis" instead of just the requirements of the national government budget.

He estimated Manila's financing requirements this year at 3.3 billion dollars, including bonds issued by the loss-making state utility National Power Corp.

Arroyo said that while the economy grew at a respectable 6.2 percent clip in the first half and the government has not defaulted on its obligations, the situation "can deteriorate as fast as we are building our precious and hard-earned gains."

Yahoo Asia: China overtakes United States as top destination for foreign investment

China overtakes United States as top destination for foreign investment

GENEVA (AFP) - China overtook the United States as a top global destination for foreign direct investment (FDI) in 2003 while the Asia-Pacific region attracted more investment than any other developing region, a UN report said.

China's strong manufacturing industry helped the country attract FDI last year worth 53.5 billion dollars, compared with 52.7 billion in 2002, the United Nations Conference on Trade and Development (UNCTAD) said in its annual report on investment flows.

Meanwhile, foreign investment in the United States, traditionally the largest recipient of such money, plunged by 53 percent last year to reach 30 billion dollars, the lowest level in 12 years, according to data from UNCTAD's World Investment Report 2004.

Flows to the Asia-Pacific region as a whole rebounded over the year to 107 billion dollars from 94 billion in 2002 driven by strong economic growth and a better investment environment, the agency said.

China was expected to continue to attract foreign companies, analysts said.

"According to our analysis, FDI in China has not peaked although their economic growth rates have fallen," UNCTAD economist James Zhan told journalists.

The outbreak of deadly Severe Acute Respiratory Disease (SARS) only had a marginal downward effect on investment activity as Asia emerged from the decline in foreign investment it had experienced since 2001, the report noted.

"Prospects for a further rise in foreign direct investment flows to Asia and the Pacific in 2004 are promising," UNCTAD's Deputy Secretary General, Carlos Fortin, said in a statement.

But the distribution of the new wealth was uneven across the region, with most of the money -- 72 billion dollars -- concentrated in north-east Asia.

Flows to south-east Asia rose 27 percent to 19 billion dollars, while the south merely received six billion dollars in FDI.

Resource-rich central Asia recorded 6.1 billion and 4.1 billion dollars flowed into the west.

The manufacturing sector remained the dominant factor that pulled investment into China, but a rise in investment in the services industry was noted elsewhere in line with the global trend, UNCTAD said.

Services, including finance, tourism, telecommunications and information technology, formed a growing proportion of foreign direct investment stock in the region -- up to 50 percent in 2002, the most recent figure available, from 43 percent in 1995, UNCTAD said.

UNCTAD said the growing tendency to shift some business activities overseas to places where labour costs are low but the workforce is skilled helped to raise the region's profile.

Asian companies were also growing in power and reach as investors in other regions, according to the Geneva-based agency.

China and India were joining Malaysia, South Korea, Singapore and Taiwan as sources of foreign direct investment, it said.

Asian firms, such as Hutchinson Whampoa of Hong Kong, Singapore's Singtel and Samsung of South Korea, again dominate the UNCTAD list of the top companies from the developing world.

Buttonwood of the Economist:The bond markets speak

The bond markets speak
Sep 21st 2004 From The Economist Global Agenda

Growth is slowing, inflationary dangers are subsiding and interest rates are near their peak. That, at least, is the message from bond markets around the world

IN TRUTH, there should be few duller things in life than investing in government bonds, a matter of clipping the coupons and getting the principal back upon maturity. Only marginally more exciting, in other words, than the M25 on a Friday afternoon or Haydn’s early string quartets. Yet government-bond markets the world over have been strangely fascinating in recent weeks because they have been rising sharply when in times past they would have fallen with a thud. After all, the price of oil is again barrelling upwards and the Federal Reserve—setter, for better or worse, of the world’s risk-free rate of interest—is raising that rate. The benchmark federal funds rate went up again on Tuesday September 21st, to 1.75%, the third increase this year. But the yield on ten-year Treasuries has dropped to a whisker over 4%; on Bunds, their German counterparts, to roughly the same level; and on Japanese Government Bonds to under 1.5%.

To be sure, there are some distorting factors driving Treasury bond prices higher and yields lower. Buying by Asian central banks, and the Bank of Japan (BOJ) in particular, is one of them. In a spree that lasted until March this year, the BOJ comfortably bought more dollars (on behalf of the finance ministry) than anyone else in history, and plonked the proceeds in Treasuries. Though it has now stopped these dollar purchases, it still has plenty of cash in the bank ($122 billion at the end of August) that it wants to invest in higher-yielding Treasuries. In both July and August, it bought $15 billion of Treasuries. Still, given the huge size of the Treasury market, such purchases probably only account for a small fraction of the fall in yields. Whether you agree with it or not, the message from the bond markets is clear: global growth is slowing, inflationary risks are transient and falling, and interest rates are nearing their peak.

The fall in Treasury yields has been as dramatic as it has been unexpected, to most investors at least. Ten-year yields peaked in the middle of June at 4.9%, and have ratcheted down ever since. Indeed, the bear market in bonds for the past year or so has really only consisted of two sharp sell-offs: from the middle of June until early September last year, and from the middle of March this year until the middle of June. Both sell-offs were caused largely by better-than-expected jobs numbers, and if anything look to be as much of an aberration as the employment reports that caused them. Despite the inflationary scare earlier this year, bond prices have actually risen in more weeks over the past year and a half than they have fallen.

That is decidedly odd. For short-term interest rates in America are still strikingly low. Real rates—that is, adjusted for inflation—are, in consequence, still negative. Very negative, in fact. Consumer-price inflation in America is currently about 3%, which makes real interest rates around -1.25%. The number-crunchers at Goldman Sachs have found that since the early 1960s, the real Fed funds rate tended to fall to just below zero at the trough of interest-rate cycles, and then rose to a couple of percentage points above it within a year. This time round, the real Fed funds rate only fell to nothing a year after the trough of the cycle at the end of 2001, and has averaged about -1.5% ever since. Monetary policy, in other words, is still very loose. If the past is a guide, and assuming that inflation remains where it is, the Fed funds rate would need to rise to 3.5-4% to bring real rates back in line.

Yet the futures market thinks that the Fed will put up rates by only another half a percentage point or so, to about 2.25%, and then stop. The reason lies in growth and inflation expectations, both of which have been falling. America’s giddy growth rate certainly seems to be slowing. The economy grew by an annualised 2.8% in the second quarter, having grown by 4.5% in the first. It is unlikely to grow much more in the third quarter.

Alan Greenspan, the Fed’s chairman, thinks this only a temporary lull; and the strong performance of equities and corporate bonds recently suggests that investors are giving him the benefit of the doubt. The key therefore seems to be inflation, which is low and getting lower. In August, core inflation—ie, stripping out energy and food—rose by only 0.1% for the third month in a row. And overall inflation will continue to fall too, or so investors think: the inflation expected in ten-year inflation-indexed Treasuries (so-called TIPs) has fallen by six-tenths of a percentage point since June.

To anyone raised in the 1970s, such expectations are astonishing. Oil is now over $46 a barrel, the real Fed funds rate is still negative, the dollar is weak and looks set to get weaker, the budget deficit is climbing to the stars, yet still markets expect inflation to fall. It seems to defy logic.

Yet logic there is. The high oil price is a tax on America, or indeed on any other country that doesn’t pump more of the stuff than it consumes. But it can be passed on to consumers in higher prices, or lower growth, or both. The market seems to have decided that it is being passed on only in the form of lower growth. It is not the only tax that is coming due: by the end of this year, consumers are to be hit by the withdrawal of tax rebates of a more traditional sort. And if growth and demand are slow enough, and competition from manufacturers elsewhere (particularly in Asia) stiff enough, consumer inflation will fall.

That, it seems, is the big change from the 1970s. And given the level of bond yields the world over, it seems to be a global phenomenon. If this is indeed the case, the more surprising thing to Buttonwood’s eye is not the level of government-bond yields, even though much disinflation is taken on trust, but the level of the stockmarket, which seems to ignore it entirely.