Mises.org: Raiders of the Taxpayer's Money by Grant Nulle

Raiders of the Taxpayer's Money
by Grant M. Nülle

October 8, 2004

Misis.org (Ludwig Von Misis Institute)

For a government as vast and powerful as America's, $60 billion is hardly a substantial amount of money, considering it boasts a large populace and economy to plunder; such a sum is a mere three-fifths of what the U.S. Army alone requested for fiscal year 2005.

In the case of the Philippines, an erstwhile vassal of America, $60bn is an exorbitant total that also happens to approximate the country's sovereign debt. Staring acute financial hardship in the face, government officials are imploring the nation, particularly Filipino taxpayers, to bail them out of a crisis of their own making.

Mountains of Debt

Despite prior foreign investment bank prognostications and concerns, economists at the University of the Philippines (UP)—a state institution—ironically brought the country's impending fiscal crunch into sharp relief. Eleven academics, many of them senior economic officials in previous Philippine presidential administrations, collaborated to identify the causes of the country's rapid accumulation of sovereign debt[i]and predicted that if left unchecked, a genuine fiscal crisis would soon befall the country.

They found that between 1997 and 2003 approximately 2.01 trillion pesos ($36.4bn) were added to the national debt, which is almost 1.5 times the debt burden –1.35 trillion pesos ($25.4bn) that existed in 1997. The outstanding government debt is at a level well above what bond rating agencies consider as the median load for similarly rated sovereigns. Divided roughly half and half between domestically and externally-held financial instruments, government servicing of these obligations could become impossible to manage if global interest rates continue to rise and recurring budget deficits cannot be attenuated.

Indeed, since 1998, the Philippines' budget balance has gone south, posting sizable budget deficits annually. The unmitigated deterioration of the government finances comes in spite of modest economic growth in the aftermath of the East Asian Financial Crisis of 1997 and 1998. Like other nations in the region, the Philippine currency suffered speculative attack, precipitating a rise in domestic interest rates by the Philippine Central Bank and a subsequent slowdown in the financial sector and wider economy.

Notwithstanding a rise in unemployment, currency depreciation and an attendant spike in inflation, the Philippine economy, relative to other East Asia countries like Indonesia, Malaysia and Thailand, rebounded rather quickly. Wide-ranging structural reforms initiated at the beginning of the 1990s, including opening an exceedingly protected economy to foreign trade, provided the country the flexibility necessary to rebound from a recession.

However, the government also resorted to public spending to stimulate growth, tapping international capital markets to plug the resultant deficit. In fact Manila's March 1999 sale of a 350m-euro bond was Asia's first debt float in the new European currency.[ii] What differentiates the period of modest economic growth in the Philippines between 1993 and the Asian Crisis and the period afterwards is an erosion of the government's finances, bulging budget deficits and burgeoning debt in the latter period.

As the UP economists enumerate, 43% of the increase in the national debt can be attributed to a surfeit of government expenditures over tax take, 19% to adverse currency movements and 37% to assumed liabilities and subsidization of state corporations.

Leaving aside the currency factor, Government Owned or Controlled Corporations (GOCCs) and the government's budget deficit merit closer examination. Beginning with the former, chronic loss-making state corporations pose an additional budgetary onus upon the government's coffers. Although its debts are not de jure obligations of the government, state enterprises can expect an implicit state bailout should it encounter financial difficulties, thus pushing the public sector debt load (as opposed to the national government) to 135.6% of GDP.

Chief among the beneficiaries of state largesse is the National Power Corporation (Napocor), a notoriously inefficient firm that lost $2.06bn last year and has had nearly $818m of debt absorbed by Manila over the past five years.

According to the country's Freedom from Debt Coalition[iii], Napocor's debt has grown from $2.2bn to $25.4bn between 1994 and 2003 and represents more than 40% of the $61.8bn debt. Unable to borrow in global capital markets, the loss-making entity has had the national government purchase its bonds and then obtain financing from foreign lenders in the government's name, including a $400m sovereign bond flotation, part of Napocor's $27.3m borrowing requirement for 2004.

In addition to current or recent government absorption of quasi-public agencies' debts, it has volunteered to service the obligations incurred during the profligate Marcos era. Even the Central Bank required financial assistance, a notion nearly incomprehensible in America or Europe where such institutions are considered omnipotent. Of course, the heroic decision of Philippine officials to assume these excesses will not be paid out of the state's or their own ill-gotten assets, but by squeezing hapless taxpayers.

Show me the money

The discrepancy between government expenditures and the property it can coerce from the populace account for 43% of the upsurge in the nation's sovereign debt. Contrary to countries that have courted fiscal crises due to increased spending, the Philippines has actually experienced a slight decline in spending levels since 1999, attributable to president Gloria Malacañang Arroyo's (GMA) determination (so far marginally successful) to cull the country's budget deficit since assuming power in 2001.

Rather, private property seizures are descending at a gait quicker then spending. The tax take has fallen from around 17% of GDP to 12.5% of GDP between 1997 and 2003. Investment banks estimate the country's rampant tax evasion totals in the billions of dollars per year. Philippine enterprises are thought to pay only 60% of the Valued Added Tax (VAT) that the state demands as tribute, while domestic financial institutions rarely pay levies on interest income commensurate to what they purportedly owe. Corruption within the government, including the Bureau of Internal Revenue (BIR) contributes to disappearing receipts. Not to be outdone, the judiciary is inclined to issue a free pass to tax dodgers. GMA has publicly condemned the endemic tax evasion and has directed the bureaucracy and citizenry to wage a Kulturkampf against it.

As for the Philippine political system, it vindicates columnist H.L. Mencken's characterization of elections as an advance auction of stolen goods. Washington's occupation of the Philippines from 1898 until 1946 imposed the American system of government on its client, complete with a president, bicameral legislature and Supreme Court. The U.S. legacy proved to be a boon to the leading families of a country encompassing thousands of islands and dozens of disparate local languages. Ambitious clans, already fluent in English (an essential in Manila) could establish provincial fiefs in the native tongue as a springboard to either house of congress and even the presidency.

Party affiliation is subordinate to filial ties; about three-fifths of the last Congress had relatives in office[iv] . Legislator loyalty can be bought (with taxpayers' money of course) to assemble majorities on any piece of legislation. What is more, elected representatives find time to grant themselves and connected friends tax exemptions (e.g. in the legal and medical professions) as well as augment their own pay for all of that taxing work. Specifically, Congress managed to almost triple its own budget over the past 15 years. But then again, the 24-member Senate does need the extra funding to discharge the expense of 36 permanent committees and 16 ad hoc oversight committees (by contrast America's upper chamber has only 16 and four permanent and special committees, respectively).

Granted, tax exemptions are always just—no matter who receives them (see Rothbard[v]) especially in the case of people who are forced to contribute to public services they themselves do not use.

Do I smell bacon?

Mounting a successful political campaign is prohibitively expensive, running into the tens of millions of dollars to conduct a serious legislative or presidential bid. In a country where a substantial portion of the population live in abject poverty, the sums expended on political campaigning is staggering. The prize, however, is lucrative: command of discretionary funds, government perks, and the ability to influence legislation and appropriations favorable to congressmen, their families and business associates.

The chief tool of personal aggrandizement at the legislator's disposal is the aptly named pork barrel. A term gleaned from the American occupiers, "pork barrel" dates back to the United States's antebellum period when masters gave African slaves salted pork stored away in barrels. Like congressmen in America, Filipino legislators mob the pork barrel to secure government appropriations for pet projects.

Marcos actually abolished the pork barrel when he disbanded congress and imposed martial law in 1972. Not until a few years after the strongman stepped down did the personal legislative allotments resume and incrementally grow in value from 1990 onward. At present, senators and representatives receive an average pork barrel (officially referred to as the Priority Development Assistance Fund) of $3.7m and $1.2m, respectively.

Nominally earmarked for development projects (roads, schools, hospitals, etc.) of their choice, legislators do deliver the goods to their constituents, although not before enriching themselves. Former Finance Secretary Salvador Enriquez reckoned that up to 45% of the pork barrel is actually lost to so-called commissions, kickbacks or rebates. The stories of Filipino firms that have won pork barrel contracts illustrate the pervasive corruption.

Neophytes quickly learn that representatives are less interested in the sales pitch than the percentage cut in the transaction they will receive. A 40 to 50 percent rebate is an acceptable sum on anything from school supplies to medicines. Payments, made in cash, are usually transferred to the legislator or a designated third party at restaurants, hotels or homes. Despite the hefty discount incurred, contractors can frequently muster a marginal profit by skimping on materials, using inferior substitutes and doing a shoddy job.

Besides retaining considerable sway over the disbursement of government money to the legislative branch, the Philippine presidency commands its own pork barrel. Dwarfing the senators' discretionary allotment by five-fold, the executive's $18.2m allotment is evenly split between a "social fund" and "intelligence fund." Although GMA has managed to keep her hands clean, her predecessor, Joseph Estrada, was impeached (but not convicted) and later ousted from office for accepting kickbacks in an illicit gambling ring and Marcos was thought to have pilfered millions.

In the same vein the civil service is bloated and inefficient; government expenditures on operating expenses and salaries constitute half the budget. Not only are Filipinos compelled to surrender their property to fund the country's bureaucracy, they receive shoddy public services from inept, indebted, and monopolistic state enterprises and government contractors as recompense, not before their "honorable representatives" lop off a portion of the tax receipts for themselves.

Dial "A" for austerity

How then is the Philippine government going to avert a looming fiscal crisis, which has been mounting for years? Of course, taxpayers will have to principally atone for the enormous debts run up by bureaucrats, legislators and managers of GOCCs.

"We are already in the midst of a fiscal crisis and we have to face it squarely wielding our courage, resourcefulness and solidarity as a nation of a people," said GMA when she laid bare the gravity of the situation on August 23, indicating that yet again the government would externalize its mistakes on the populace at large.

The federal government's medium term fiscal plan is designed to obtain solvency over the next six years. It plans to exact revenue (projected take) by implementing a two-step increase in the VAT rate ($362m); tax on telecommunications franchises ($91m); adoption of gross income taxation for corporate and self-employed payers ($305m), indexation of tobacco, alcohol, etc. excises ($127.3m); augment excise on petroleum ($540m); rationalization of fiscal incentives ($91m) and a general tax amnesty. Failing legislative endorsement of these measures the executive has mooted reversing the 1997 income tax exemption granted to the country's 7m citizens working abroad.

Others have pointed out that the best performing (and lightly taxed) sectors of the economy—exports and agriculture—deserve to assume a greater share of the burden. Shame on these people who do not appreciate the connection between low taxes and high growth.

The taxmen have been encouraged to vigorously collect all unpaid interest income withholdings that banks have declined to surrender. The ongoing professionalization of the tax bureaucracy will continue, albeit marred by imbedded corruption in the BIR. Recently some staff refused to collect taxes when one of their superiors tried to proscribe bribery in the ranks.

Moreover, public service user fees—specifically the electricity rate charged by Napocor—will climb. From 26 September onward, the price per kilowatt-hour will provisionally rise by 40%. Not only are Filipinos already forced to defray the debts of this tax-consuming monstrosity, but now are also compelled to devote a higher share of their income to the dismal services provided by this monopolistic entity.

Coupled with its proposals to coercively seize legitimately held property, the Philippine government has plans in the works to employ its stolen goods more efficiently. Administrative changes are to be implemented, requiring cost cutting in the bureaucracy on utilities, travel, supplies, etc. Superfluous offices are to be junked or consolidated and a voluntary trimming of the public payroll is in the works. GOCC creation—an oft-abused presidential prerogative—is to be frozen indefinitely and the 2005 budget proposal envisages reducing pork barrel allocations by 40%; the government is even preparing to privatize Napocor.

Furthermore, the executive is seeking to pass a fiscal responsibility bill, which will impose a debt cap on government borrowing and prohibit new spending without new taxes. Finally, the president will seek legislative authority to revamp executive departments and agencies as well as GOCCs. There is talk of limiting Internal Revenue Allotments (tax revenue transfers) to local governments by as much as 25% ($2.64bn) keeping that money in the federal government's accounts.

Taken together, the government's revenue and expenditure proposals promise by 2010 to balance the budget, increase the tax take, and reduce the public sector debt burden substantially.

Fuzzy math

Despite these ambitious measures, it remains to be seen if the supposedly radical rationalization measures evolve into something more than cosmetic reshuffling. Quite obviously the second element of the fiscal responsibility law is dreadful; the government's ability to tax and spend is at the root of the debt problem.

In the meantime, the government's projected 2005 budget of 907.6bn pesos ($16.5bn)—including $2.45bn in subsidies—is 5.3% higher than the previous year. Somehow an additional $2bn request for unspecified items and cash deficit has been left off the tender. Even GMA's promise to slash travel expenses fail to hold water, as the budget provides an extra $13.3m for this purpose.

Equally mysterious, the $6.26bn of principal payments due in 2005 has been left out of the proposal, which when added would allow the budget total to exceed the 1 trillion peso threshold for the first time ever. One of Asia's most spendthrift states owes $11.81bn in interest and principal repayments next year, an 81% increase since 2002[vi]. The budget deficit is projected to be another $9.31bn, financed by domestic borrowing. Moreover, the current presidential administration—which in only three years was able to borrow more than its two most recent predecessors managed to do over a span of eight years—is preparing to spend more than it pilfers from the populace for the next four years, prompting it to amass further debt.

As appealing as the moratorium on GOCCs and the vague promise to limit government guarantees to these firms may be, it does not adequately address the chief culprit of the Philippines' gaping fiscal deficit and substantial debt: the GOCCs themselves. Records from the country's budget department indicate that state corporations are collectively expected to register at least a $2.4bn loss during Fiscal year 2004. Blithely ignoring their financial drain on the country, many top GOCC administrators have awarded themselves lavish pay packets and discretionary funds (by Philippine standards) and then asked the government for subsidies and bailouts.

In the case of Napocor, the 40% provisional rate increase, with another unspecified rise scheduled in another 6 months, will merely serve to help it pay off interest payments amounting to more than $1bn over the next year. A clutch of company executives were recently paid $218m in retirement and severance pay and then subsequently rehired with a higher salary. After a bout of obfuscation by Napocor's management a government audit of the firm's books in 2003 discovered $2.55bn of accounting irregularities. Quite rightly, the Senate's Ways and Means Committee has deplored the systematic waste at the power provider.

Indeed, Napocor's $2.06bn loss in 2003 far exceeds the $618m per annum (before the 40% reduction in pork barrel) spent on corruption-riddled congressional pork barrel and the legislature's budget. Before Napocor is privatized Philippine taxpayers are poised to assume $9.1bn of its debts.

Perhaps a more politically palatable and positively outlandish method of plugging the budget gap would be a plan floated by President Arroyo in early 2003. She claimed that more than $18bn-worth of gold rests within the island of Mindanao's Mount Diwalwal. The Japanese occupation forces during the Second World War are reputed to have left behind buried treasures all over the country, which have enticed several Filipino presidents (along with Thai and Indonesian authorities in their own countries) to launch abortive, Indiana Jones-like searches for the missing caches. Indeed, Estrada had the garden of a presidential residence overturned in search of loot[vii].

Debt repudiation, not service

The aforementioned UP Economists reckon a debt crisis cannot be avoided for more than three years and that action must be taken within the next year to assuage financial markets. In April 2003, Standard & Poor's S&P lowered the Philippines long-term foreign currency rating (BB+ to BB), followed by Fitch in June 2003 and Moody's (Ba2 to Ba1) in January 2004. On September 8, S&P critisized the Philippine government's willingness to enact reforms and admonished authorities to reverse its negative fiscal trajectory in a fundamental and sustainable manner, lest it court an increasingly onerous debt burden.

Rather than comparing Manila's plight to that of Argentina, which defaulted on its sovereign debts in late 2001, one need look no further than the crunch and contraction that the Philippines suffered between 1983 and 1984. Spearheaded by the licentiousness of GOCCs and abetted by brisk petroleum price rises, the rapid accumulation of government debt during the late 1970s and early 1980s prompted the Marcos regime to default on its foreign obligations in 1983. An acute peso depreciation ensued, and the country plunged into economic and political turmoil for the rest of the decade.

On the heels of GMA's national announcement of impending fiscal difficulties, her subordinates quickly assured international capital markets that debt service would not be interrupted. They stressed that the definition of "fiscal crisis," as accepted by the IMF and credit agencies, is a situation that occurs only when: a country is in default, its deficit is unsustainable and the country does not have access to capital markets. S&P cautioned Philippine authorities that the recent 40% increase and future rise in Napocor's power rate would not save the company, much less the country, and urged authorities to introduce additional tax measures and enhance collection.

The S&P's advice indicates a proper method to resolve the Philippines debt situation, albeit not in the manner the rating agency advocates. Instead of devoting more of their income to Manila's debt problem, the Filipinos should press the government to repudiate all outstanding obligations to multilateral and private lenders alike.

To the casual observer this suggestion is anathema for it violates the sanctity of contracts. However, as Murray Rothbard[viii] correctly explained, there is a fundamental distinction between private and public debt.

In the former case, where a low-time preference creditor lends money to a high-time preference borrower in exchange for repayment plus interest, to repudiate one's debts is tantamount to depriving the lender of his property, which is indefensible. In regard to public debt, governments do not pledge their own assets, but taxpayers' instead, with creditors cognizant that the principle and interest will be paid through the involuntary confiscation of private property—taxation. In effect, both sides are complicit in the violation of property rights of a third party in the future, which scarcely deserves to be acknowledged as a contract.

Beyond the dodgy status of sovereign borrowing, debt repudiation is beneficial in that it immediately alleviates the citizenry of onerous repayments on obligations issued by present and previous governments. Politicians, bureaucrats, and their constituencies that receive succor at the public trough parasitically exist at the expense of productive tax-paying members of society. Why should the latter be made to pay for the former group's livelihood, much less its mistakes?

More importantly, by denying the Philippine government credit, as lenders are wont to do, the state will be compelled to operate within the confines of a balanced budget, certainly an unorthodox but necessary development.

Undoubtedly, the Philippine economy will be buffeted by a severe downturn as the country's private sector incurs the wrath of international capital markets. However, when the citizenry is relieved of massive tax-funded repayments on these obligations and no longer saddled with a credit-worthy government, foreign lending will return to invest in promising private enterprises. Likewise, indigenous capital formation can emerge as the profligate public sector is reined in. Fortunately, the estimated $7bn in annual remittances from Filipino workers abroad can serve as seed money for productive investments.

With respect to private creditors, as shameful as the blatant deprivation of the funds loaned to the Philippines may be, such arrangements clearly infringe third-party property rights and are an affront to liberty. As Rothbard suggested, a government mulling unilateral cancellation of its debts could at least partially allay creditor contempt by selling state assets and channeling the receipts to servicing its obligations. Auctioning off ill-gotten properties would divest the government of its coercion-acquired and maintained ascendancy.

Hopefully, debt repudiation by the Philippines would serve notice to prospective lenders that states, the only entity in society besides criminals that exist at the expense of others, are parasitic and wasteful consumers of capital undeserving of investment.

Grant M. Nülle is a Research Fellow with the Ludwig von Mises Institute. Contact him at grantn007@yahoo.com. Post comments on the blog.

[i] De Dios, Emmanuel S., et al. "The Deepening Crisis: The Real Score on Deficits and the Public Debt." University of the Philippines.
[ii] Milo, Melanie. "Contagion Effects of the Asian Crisis, Policy Responses and Their Social Implications." Philippine Institute for Development Studies. Discussion Paper Series No. 99-32. Dec. 1999.
[iii] "Past and Present Administrations Responsible for State-owned Power Firm's Heavy Loss." Freedom from Debt Coalition. 4 May 2004.
[iv] Democracy as Showbiz." The Economist. 9 July 2004.
[v] Rothbard, Murray N. Power and Market. 1970: 120–21.
[vi] "RP's 'Real' Debt Service Not Indicated in 2005 Budget." Manila Times. 28 August 04.
[vii] "All That Glisters..." The Economist. 16 January 2003.[viii] Rothbard, Murray N. "Repudiating the National Debt." Mises.org. 16 Jan. 2004.

D.R. Barton, Jr. of Trader's U: Joe's Loss Is Your Gain Controlling the Downside

Joe's Loss Is Your Gain: Controlling the Downside
by D.R. Barton, Jr.

President, Trader’s U

"Big losses continue to haunt us; nice profits are soon forgotten." ~ Shakespeare's Julius Caesar (liberally paraphrased by DRB)

I wasn't worried about Joe. He had the money to lose; but I could tell by his tone that the phone call wasn't about the money. There was fear in the voice on the other end of the line.

"How long have you been in the position?" I asked.

"It started out as a day trade in that semiconductor stock, Rambus," Joe replied. "But it dropped big on me that day and I just stayed in overnight, hoping it would come back up the following day. Then it was down the next day, and I just knew it that it would move up again. That was four weeks ago."

$320,000 is a lot of money to lose in four weeks. Fortunately, it was a relatively small chunk of Joe's net worth.

Joe got into the trade on a rumor that the chipmaker was going to make a big announcement. He was thinking about the big bucks he would make by being on the right side of some good news. But the news never came. And when the semiconductor sector took a big hit in early 2001, Joe's stock was cut in half in a matter of weeks.

While Joe had several miscues in this trade, the biggest mistake that he made was getting his priorities backward. He put his zeal for profits ahead of the need to protect his equity.

Let's use the tuition that Joe paid - and learn how you and I can leave the rookie mistakes behind and adopt the mentality of elite traders.

Here's how to make safeguarding our cash the number one concern BEFORE we enter a trade or investment...

Controlling Risk: Every Trader's Top Priority

I've had the pleasure of trading with and learning from some incredible traders. I also get to teach workshops where I hear from traders and investors of all experience and skill levels.

One difference that is always striking to me is between what I hear the pros talk about and what newer traders think.

When an experienced trader looks at any trading opportunity, the first thing he or she asks is, "Where will I get out if I'm wrong?"

In contrast, those new to the game are often lured to trading by the idea of big profits. A typical question asked by a new trader is this, "How much can I make if this works?"

Top traders are obsessed with controlling their risk and preserving their capital. This is their TOP PRIORITY.

The single biggest mistake a trader or investor can make is to hold onto a loser and give it a chance to grow beyond your intentions.

We hold onto a day trade loss and it turns into an overnight trade...

The overnight trade turns into a bigger, intermediate-term swing trade loss.

Then the trade that started out as a "little loss that came along one morning" turns into an unintended part of your core portfolio. Oh yeah - this "little addition" carries along with it a loss that is chewing up 10 or 20 percent (or more) of your equity. And it's still growing.

These are the type of trades that destroy accounts and end traders' careers before they even get started. As Shakespeare put it, these trades are "the evil that men [and women] do." And they sure haunt us for a long time.

But there is a better way - and it starts with your mind.

Think About Risk First and Reward Second

Top traders know that this game we call trading and investing is pretty simple, from a statistical viewpoint. Big moves do come along. Our goal, whether we are day trading or making long-term investments, is to be on the right side of those moves. And if we happen to get caught on the wrong side of the move - WE GET OUT! No questions. No hesitation.

Investment U has long been an advocate of using stops when entering trades. This is a great way to think about limiting risk. When you use a 25% trailing stop, you know precisely what your risk is before you enter the trade.

How You Can Use "Risk Control Thinking" In Your Trading

1. Before you decide to use any trading system or newsletter recommendation, make sure that there are explicit price levels that serve as the "get out if we're wrong" point for each trading signal or investment recommendation. If these "stop loss" points are not provided, find another system or advisor.

2. Work on changing your thought process. Everyone gets excited about the potential for big profits. But the folks that stick around for the long term think about "risk control" first and then "size of reward" second. Start to look at every trade or investment opportunity by first asking, "When will I get out if I'm wrong?" This applies equally to day trading, long-term investing, real estate projects or business ventures.

3. Once you know the "worst case" loss level (your stop loss), determine the size of your position. As a rule of thumb, do not risk more than 1% of your equity on any one trading or investing idea. When you are just starting out, trade even smaller size (one-quarter to one-half of a percent). As you gain expertise in a trading or investing strategy, you can increase this amount if the strategy or system is very successful, but not above a maximum of 2% of your equity.

4. Finally, don't forget about the reward side of the trade! Once you know the amount you are going to risk, make a reasonable estimate of the reward you could receive if this trade or investment works our well. DO NOT TAKE THE TRADE if the reward-to-risk ratio is less than 2:1. For most trading time frames that are longer than a few days, look for reward-to-risk ratios that are 3:1 or more.While it will be hard at first, try to set aside that warm feeling you get from thinking about the potential profits from a trade. Think first about managing the risk. Then (and only then) are you ready to look at the reward side of the equation. Dream big dreams, but keep your feet firmly planted on the ground.

Great trading,

D.R.

Dr. Krassimir Petrov: Oil performance in a worldwide depression

Oil performance in a worldwide depression

September 29, 2004

by Dr. Krassimir Petrov

In a previous article called “China’s Great Depression”, I postulated that China must necessarily fall into a depression, probably comparable to the American one from the 1930s, which in turn will spread to become a worldwide depression. In response, many readers asked whether in such a depressionary environment the price of oil would go up or down. The straightforward answer is that in an inflationary bust, the price of oil will go up, and in a deflationary bust—down. Of course, the response is evasive, provides no analysis, and answers an ill-defined question. Therefore, the goal of this article is to explain the importance of the question, to define its scope properly, to answer it with sound economic analysis, and to summarize our results.

Over the next decade, oil fundamentals may be characterized as 10+. Oil supply is at or near its “Hubbard’s” peak, and oil is currently pumped at close to 100% capacity. Therefore, growth of oil supply is rapidly slowing down and is expected to decrease in the coming years. On the other hand, China’s and India’s industrialization will continue to drive oil demand at growth rates higher than the growth rates of oil supply, and as a consequence, the price oil has to go much higher in order to ration the relative scarcity of oil supply. In this environment of strong fundamentals for oil, a booming worldwide economy will guarantee much higher oil prices; however, in a worldwide recession, the issue becomes whether the strong oil fundamentals will nonetheless outweigh a slowdown in oil demand. Precisely this issue motivates our present analysis.

The proper definition of the problem requires investigation of the price of oil (1) relative to the U.S. dollar, (2) relative to strong fiat currencies, (3) relative to gold and silver, and (4) relative to a basket of commodities. Below, we investigate each in turn, although I would like to respectfully acknowledge Marc Faber’s seminal contribution in (1) and (2).

The U.S. dollar is fundamentally unsound. It has been used for decades to monetize U.S. government debts and to pay for trade deficits. As a result, the dollar has been overissued in the U.S. and overaccumulated by foreigners. In a worldwide depressionary environment, two decisive factors will drive the dollar’s value substantially lower. First, the injury to the dollar will come from foreigners decumulating their dollar-denominated investments. In a depression, foreign banks will fall on hard times, and they will have little choice but to shore up their reserves by selling foreign-denominated assets and repatriating their capital home. In addition, foreign governments will attempt to stimulate their economies with lowered interest rates, increased domestic investments, and bigger government spending. All of these will be better accomplished by repatriating foreign investments home rather than by pure monetary stimulus, because the repatriation will actually increase the pool of savings within their economies and provide a sound, sustainable basis for the stimulus, while a pure monetary stimulus will provide a credit-based, unsustainable stimulus that is doomed to failure. Second, to add insult to injury, the dollar will come under additional pressure from the Fed’s own inflationary policy, now fighting the more pronounced deflationary forces. No doubt, “Helicopter” Ben will step up the printing press, and as a result, U.S. money supply will continue to increase, at least for a while, and some of the freshly printed dollars will be sold on the foreign exchange markets for better stores of value. Thus, a depressionary environment will exacerbate the dollar’s problems and the dollar is likely to fall a lot more than oil due to its inherent vulnerability. As a result, in a depression, the price of oil is likely to go up in U.S. dollars.

In terms of strong foreign currencies (e.g. Swiss Franc), I believe that in a depression the price of oil will actually fall. These currencies, by definition of being strong, will hold their value relatively well, and their demand will be relatively stronger than demand for oil, because a flight to safety will increase demand for those currencies, while depressionary forces will reduce oil demand. This, of course, assumes no oil wars, terrorism, local political instability, or other unforeseeable disruptions of oil supplies; given such a disruption, all bets are off, and oil will likely rise in all fiat currencies. Under normal conditions, however, the price of oil is likely to fall in terms of strong currencies.

Gold shines bright in a depressionary environment. It is the ultimate safe haven, and in times of crisis it holds its value better than anything else. In a flight to safety, it has always been the top choice for investors. The reason is that in times of crisis, sinking profits crush stocks, looming defaults pressure bonds, credit-crunch chokes real estate, and escalating monetization devalues fiat currencies. In such an environment, there is simply nowhere to run but gold. Even though demand for gold as a commodity collapses, its demand as the only safe money skyrockets; the latter dramatically overcompensates the former, and total demand for gold increases substantially. As a result, gold (and silver) is likely to rise against all currencies, weak or strong. However vital for human civilization, in a depression, oil is no match for gold, and is certain to fall in terms of gold.

Demand for commodities generally drops in a depressed worldwide economy. We base our argument on the fact that oil demand is very inelastic, even when compared to the elasticity of commodities. Thus, in a strong economy, oil prices generally rise relative to commodity prices, and in a weak economy—fall relative to commodity prices. From an Austrian point of view, oil may be regarded as a higher-order capital good relative to other commodities, and therefore in a bust environment, it follows from Austrian theory, that oil prices will fall relative to commodity prices. However, we must acknowledge that the inelasticity argument is not independent of the higher-order Austrian argument, for the higher-order argument naturally implies relative inelasticity. Therefore, one may expect that in a depression, the oil price will most likely fall in terms of a commodity index, such as the CRB, provided that there are no oil disruptions, as already indicated above. To reiterate, with oil supply disruptions, oil is certain to outperform every single commodity, except gold and silver.

We will note a number of important analytical properties. First, nowhere in our analysis did I assume inflation or deflation. Instead, I relied entirely on demand and supply characteristics of a bust, whether inflationary or deflationary. Second, I was able to resolve the problem in terms of currencies because of their explicit choice: the dollar being inherently weak, and strong currencies, being inherently strong. For currencies in the middle of the “strength” spectrum, the answer is considerably harder and somewhat indeterminate. Third, for gold and silver I applied the “safe-haven” argument. Finally, for commodities I applied the relative inelasticity argument.
To conclude, in a depressionary environment, the price of oil will go up in terms of U.S. dollars, and will fall in terms of strong currencies, gold, silver, and a basket of commodities. It follows that the appropriate investment strategy for investors should involve the accumulation of gold, silver, strong foreign currencies, and government bonds denominated in those currencies.

Dr. Krassimir Petrov is a disciple of the Austrian School of Economics and spent this summer at the Mises Institute of Austrian Economics at Auburn , Alabama

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