10 Big business blunders
Ego and greed: a common recipe for executive error
By Alex Markels
Glance through the following list of business blunders, and you may conclude that the common denominator in financial failure is outsize hubris. Yet arrogance alone doesn't guarantee disaster. After all, if you're seriously lucky as well, the combination can catapult you into the kind of power spot that billionaire Mark Cuban plays on TV's The Benefactor.
For a tried-and-true approach to calamity, there's always the sort of book-cooking that prevailed in the 1990s. But that's an increasingly risky proposition given Eliot Spitzer's ever expanding universe of white-collar probes. And there are plenty of legit roads to ruin. Key ingredients typically include behavior that often accompanies hubris, most notably a cocksure rush to judgment, without doing enough homework. Before making big decisions, great corporate leaders "dive into the brutal facts like pigs in slop," says management guru Jim Collins, who studied the differences between winning and losing management styles in Good to Great: Why Some Companies Make the Leap ...and Others Don't. "Lesser companies tend to . . . just act."
He notes that while some of business's top performers take ample time to study new markets (see Walgreen's, whose stock has outperformed the market 15-fold since 1972), the Internet-era mantra of being "first to market" is almost always a shortcut to a bad decision (see Drugstore.com). So is the chase for the mergermaniac's holy grail: synergy, the frequently fatal belief that 1 plus 1 equals 3. Then, of course, there's the sort of thickheadedness that comes from believing that technology itself is the true holy grail.
In fact, the best corporate decisions are often the most obvious: hiring good people, training them well, and shepherding them up the corporate ladder. Yet those stories aren't nearly as much fun to read. So in the spirit of learning from (and laughing at) the mistakes of others, we present our list of best (or should it be worst?) business blunders.
AOL-TIME Warner: When 1 + 1 = 1/5th
They called it "convergence": a melding of new technology and old media that would revolutionize the business world. "By joining forces with Time Warner, we will fundamentally change the way people get information, communicate with others, buy products, and are entertained," America Online founder Steve Case said of the merger of his Internet pioneer with old media publisher Time Warner in January 2000.
But like so many other promises of synergy between merging companies, "it was a joke," says Harvard's Rosabeth Moss Kanter, author of Confidence: How Winning Streaks and Losing Streaks Begin and End. "When the people at Time Inc. refused to use AOL as their E-mail provider, it was clear how badly things were going."
Although the combined company predicted it would break $40 billion in revenue and $10 billion in profits within a year, its failure to realize the synergies--along with the collapse of the online ad market--assured that the merger would soon take its place among the worst in U.S. business history. Today, after a $54 billion write-down in the value of the deal, Time Warner is valued at a mere $76 billion, one fifth of the companies' combined market worth on the day the merger was announced.
For AOL, the deal was probably a lifesaver. Case was able to use AOL's lofty stock price to buy a highly profitable company with more than 70 years of publishing experience. On the other hand, Time Warner's bigwigs "got silly and drank the convergence Kool-Aid," says business book author Roger Lowenstein. And they're still recovering from the hangover.
The Hunt Brothers: Hi-Ho Silver
The little old ladies lined up outside of London's Hatton Garden jewelry stores in the fall of 1979 should have worried Bunker and Herbert Hunt. If enough of them were willing to sell their silver heirlooms for scrap, then the Hunt brothers' attempt to corner the world's silver supply was surely doomed.
But Bunker Hunt, second-oldest son of Texas oil tycoon H. L. Hunt, was convinced he could turn silver into gold. A big-betting oilman, Bunker became one of the richest men in the world at age 35. Beginning in the early 1970s, he and younger brother Herbert made a tidy little sum on 200,000 ounces of silver they purchased, as silver prices doubled from $1.50 to $3 an ounce.
Figuring bigger is better, over the rest of the decade they purchased an additional 59 million ounces, roughly a third of the world's supply, pushing the price to $50 an ounce and earning the Hunts a paper profit of about $4 billion. But the high prices sparked increased supplies of scrap silver and mining investment. Prices dropped.
Tapped out of cash and unable to liquidate their silver hoard without driving the price down even faster, the Hunts watched as the price fell 80 percent in a matter of days. The following year, the two were named Boneheads of the Year by the Bonehead Club of Dallas. Its motto: "To learn more and more about less and less, until eventually we shall know everything about nothing."
New Coke: It's the Real Thing ... Not!
Coca-Cola executives figured they had finally found the solution for their ailing brand. Concerned that the Pepsi Challenge campaign was dangerously eroding Coke's market share (which had fallen by nearly half since the 1950s), they formulated New Coke in 1985, then gathered focus groups to compare the two in blind taste tests. When the new formula beat Pepsi hands down, they figured they had a winner. Yet within hours of its rollout, it was clear that something had gone sour. "Damn!" exclaimed the wife of a Coca-Cola bottler upon her first sip. "This will never sell!"
Thousands of complaints flooded the company in the weeks after New Coke hit the streets. At first, the company's marketing chief called such complaints "relatively insignificant." But three months and 400,000 angry calls and letters later, New Coke faded from store shelves in favor of "Coke Classic."
Conspiracy theorists believed the whole episode was merely a deft marketing ploy to reinvigorate the brand. After all, Coke's decision to reverse itself was soon rewarded by growing sales and a stock price that reached an all-time high. The truth, however, was that while the focus group leaders had asked whether tasters liked New Coke better than Pepsi, "they never bothered to ask people how they would feel if old Coke was taken away," says Constance Hays, author of The Real Thing: Truth and Power at the Coca-Cola Company.
Long-Term Capital Management: Too smart by half
They were the epitome of the rational man: Two Nobel Prize-winning economists, a former Federal Reserve vice chairman, and 25 egghead Ph.D.'s--all armed with banks of number-crunching computers. Recruited to join Long-Term Capital Management in 1993, they were led by John Meriwether, the legendary former Salomon Brothers bond trader and star of the book Liar's Poker. Meriwether had made billions for his former employer through trades based on computer-generated charts that plotted historical relationships between related securities, like those of merging companies. In 1993, the team pulled in hundreds of millions from wide-eyed investors too impressed to ask probing questions, then leveraged the money by borrowing billions more.
The strategy was a wild success at first, netting investors an annual return of more than 40 percent in 1995 and 1996--even after the partners had grabbed a hefty 2 percent management fee and a 25 percent share of the profits.
But when a host of unexpected events (Russia's debt default, a collapse in the market for mortgage-backed securities, and a currency crisis in Asia) sent the global bond market into a tailspin in 1998, traders stopped acting like the rational buyers and sellers the eggheads had assumed. "They had programmed the market for a cold predictability that it never had," author Lowenstein writes in When Genius Failed: The Rise and Fall of Long-Term Capital Management. "They had forgotten the human factor."
XEROX: Undiscovered treasure
It must have been a sight for sore fingers: an electronic typewriter that could display written correspondence on a screen, store it with a click of a button, then send it around the office and print out hard copies?
Demonstrated at "Futures Day" during a meeting of Xerox's top managers in 1977, the fruits of nearly a decade of study at the company's Palo Alto Research Center caught the eyes of the executives' spouses, many of whom were former secretaries. But most of their manager husbands "just didn't get it," says Douglas K. Smith, coauthor of Fumbling the Future: How Xerox Invented, Then Ignored, the First Personal Computer. "So Xerox turned it down."
Meanwhile, Apple Computer's founders copied much of the technology in their Macintosh PC. And Xerox researchers like Bob Metcalfe, who had invented the Ethernet local area network, left and started their own companies, leaving Xerox largely out of what would become a trillion-dollar industry.
Under pressure to produce profits, the fast-growing Xerox "didn't see PARC's innovations as adding much more than incremental growth."
Not that Xerox was the first to make this mistake. Some 35 years earlier, IBM, Kodak, and General Electric all took passes on a new technology that could reproduce paper copies within minutes. "What's wrong with mimeographs?" IBM executives are said to have asked when they turned down the chance to buy the technology that would go on to empower Xerox.
Donald Trump: Rolling snake eyes
'You're fired!" That's exactly what any sensible board of directors would yell at a chief executive who'd run his company into the ground from Day 1. But when the CEO is Donald Trump, it's apparently easier said than done.
Convinced that Atlantic City would soon eclipse Las Vegas as the nation's gambling center, Trump invested billions beginning in the mid-1980s on behemoths like his over-the-top Trump Taj Mahal. "I can't get into trouble in Atlantic City!" he boasted at its opening in 1990.
But the Taj cannibalized revenue from its neighboring properties, the Plaza and the Castle. And when the recession of 1990-91 sent customers fleeing from the blackjack tables at all three, Trump couldn't pay the more than $1 billion in debt he'd rung up. Narrowly averting bankruptcy, he managed to keep control of the properties by relinquishing much of his original stake and taking the company public in 1995.
Yet Trump Hotels hasn't posted an annual profit since. From a high of $34 a share in 1996, the company's stock sank below 20 cents after it was delisted by the New York Stock Exchange in September. Burdened with a crushing $1.8 billion debt, the company declared bankruptcy for a second time last month. Amazingly, however, Trump saved his CEO status, thanks, in part, to his ponying up $72 million ($55 million of it in cash) to help revive the company.
It's a performance that would make his present-day apprentices blush.
IRIDIUM: The sky really is falling
Blame it all on Karen Bertiger. Just married to a Motorola engineer in 1985, she refused to go on her honeymoon because there was no cellphone service on Green Turtle Cay in the Bahamas. "If you are such a smart guy," she told her husband, Bary (who had patented the communications system for the Voyager spacecraft), why is it that "I still can't make a cellular phone call from anywhere on Earth?"
Thus began one of the largest fiascos in business history. Seizing on the idea, the can-do crowd at Motorola ran Bertiger's idea up the corporate flagpole. The leviathan effort would cost billions, but CEO Robert Galvin figured that by spinning it off and teaming with a host of worldwide partners, it just might work. More than a decade and $5 billion later, Iridium's network of 66 low-flying satellites was finally launched in 1998. "The potential uses of Iridium products are boundless," Iridium's then CEO Edward Staiano decreed.
Yet Iridium's brick-size phone was a far cry from the tiny cellphones flooding the market. Even worse, users had to be outdoors to make the line-of-sight connection needed to communicate with its satellites.
With fewer than 50,000 subscribers by 2000, the company declared bankruptcy. And the low-flying satellites were expected to fall from the sky. But before they did, Dan Colussy, who'd made a fortune refurbishing aircraft, purchased Iridium for $25 million, paying half of one cent for every dollar originally invested--perhaps the greatest deal since the Louisiana Purchase. With lower airtime fees and handsets that cost half what they did in 1998, the company recently announced that its subscriber base had grown to 100,000 and that it had even turned a before-tax profit.
IBM: Error message
Hindsight can be a painful thing. Just ask Gary Kildall, the inventor of the CP/M operating system, one of the first designed for a personal computer. In 1980, destiny knocked on his door in the form of a team of blue-suited IBM executives. They'd been referred by none other than Bill Gates, who'd struck a deal with Big Blue to create software for IBM's first personal computer.
Caught off-guard by the remarkable popularity of the Apple II computer, the IBM ers had decided to rush their own version of the PC to market. But instead of building it from scratch, they decided to slap it together with off-the-shelf parts. Gates was happy to oblige with his programming software, but he lacked an operating system, so he referred them to Kildall. His wife, however, sent them packing after refusing to sign IBM's dense nondisclosure form.
That's when Gates & Co. stepped back in. A friend across town also had an operating system called QDOS (for "quick and dirty operating system"). "We just told IBM, 'Look, we'll go and get this operating system from this small local company, we'll take care of it, we'll fix it up, and you can still do a PC,'" Microsoft CEO Steve Balmer explained in the documentary Triumph of the Nerds .
Microsoft purchased unlimited rights to QDOS for $50,000, tweaked it, and sold it to IBM for $80,000. But with one proviso. While IBM would have the right to install it royalty free in as many computers as it wanted, Microsoft would retain the right to sell the renamed MS-DOS to others. "No problem," replied the IBMers, who couldn't imagine who else might want it.
AT&T: Dialing the wrong number
The right choice seemed obvious to Charles Brown. Forced by a trust-busting federal judge in 1982 to jettison either AT&T's regulated local telephone monopoly or its equipment business, the AT&T CEO chose to keep hardware. With the personal computer business taking off and the melding of computers and telecommunications right around the corner, AT&T could leverage its vast resources to dominate the PC market and transform its stodgy image and middling stock price. AT&T Information Systems was soon born, and the company's first IBM-compatible PC, built with Italy's Olivetti, debuted in the summer of 1984.
But the computers weren't fully compatible. Moreover, AT&T's technologists weren't keen on working with outsiders. Over the next five years, the company lost as much as $3 billion. Yet AT&T's fatal attraction for PC s continued as new CEO Robert Allen set his sites on NCR, which AT&T purchased in a 1991 hostile takeover for $7.5 billion, twice what NCR shares sold for before AT&T came calling. But over the next five years, NCR lost nearly $4 billion before being spun off for less than half of what AT&T paid for it in 1991.
In the end, Brown was right about the coming PC wave. But AT&T chiefs made the classic "industry of the future" mistake, says Harvard's Kanter, "They arrogantly leapt into something totally new, thinking their past success in telephones would add up to the same in computers."
Boston Chicken: Laying an egg
Hell hath no fury like a coupon clipper scorned. Or, at least, that's how executives at Boston Market (originally Boston Chicken) first explained why they were having trouble keeping up the momentum at their restaurant chain in 1997. When management attempted to wean penny-pinching customers off a popular coupon promotion, they ran to the nearest KFC. For a company that touted itself as the next McDonald's for its "home-meal-replacement" strategy of putting a rotisserie chicken in every pot, the flattening sales led to its stock's falling more than 82 percent from its $41.50 high at the end of 1996. Shareholder lawsuits accused the company of hiding more than $750 million in losses incurred by its franchisees, which had borrowed up to 80 percent of their start-up costs from the company. Though most franchisees were losing money as the chain grew to more than 1,100 stores, the company showed a profit, partly by booking the loan repayments as income. In a move similar to those later detected at Enron and elsewhere, "they adopted a financing strategy to keep start-up costs off their balance sheet," says Dartmouth's Sydney Finkelstein, who interviewed company executives for his book Why Smart Executives Fail and What You Can Learn From Their Mistakes. Instead of Boston Market's becoming the next McDonald's, McDonald's became the next Boston Market, purchasing the by-then-bankrupt company for a pittance in 2000. How's that for eating crow?
Wednesday, November 10, 2004
IPS News: French Role in Côte d'Ivoire Questioned
French Role in Côte d'Ivoire Questioned
Thalif Deen
UNITED NATIONS, Nov 9 (IPS) - France is coming under fire for its heavy-handed action in destroying virtually the entire air force of its former colony Côte d'Ivoire in retaliation for the killings of nine French soldiers and a U.S. aid worker last week.
''We deeply regret the unfortunate incident,'' Ambassador Philippe Djangone-Bi of Côte d'Ivoire told reporters Tuesday. ''But France was wrong in its unilateral reprisal,'' he added.
He said his government wants the Security Council to make a pronouncement about ''our right as a sovereign nation.''
''We love France, it is a friendly country,'' said Djangone-Bi, but its troops had no right to ''fire at our presidential palace, destroy our forces, humiliate us, and shoot at our civilians from helicopters.''
Asked to respond, French Ambassador Jean-Marc de La Sabliere told reporters Tuesday the Ivorian Armed Forces carried out ''a deliberate attack'' on French troops.
''France had the right to retaliate. No one (in the Security Council) questioned us. This is not an issue,'' he added.
French President Jacques Chirac's decision to destroy the Ivorian Air Force was ''widely supported by the Security Council,'' de La Sabliere added.
As part of a combined French-U.N. peacekeeping force, Paris has more than 4,500 troops in Côte d'Ivoire, where a civil war has partitioned the territory into a government-held south and a rebel-held north.
The U.N. Operation in Côte d'Ivoire (UNOCI), created by the U.N. Security Council in April 2004, has a military strength of over 6,000 peacekeepers. But in an unusual arrangement, French troops have the right to act alone and do not come under the military authority of UNOCI.
The two forces are mandated to monitor a May 2003 cease-fire and peace agreement that was signed by the rebel forces and the government of President Laurent Gbagbo. ''The French should not be in Côte d'Ivoire'', says Bill Fletcher Jr, executive director of Washington-based TransAfrica Forum.
''There should be either a United Nations force or an African Union (AU) force. The French clearly have an interest in retaining their role as the hegemonic power over their former colonies,'' Fletcher told IPS.
Côte d'Ivoire gained independence from France in 1960.
Fletcher also argued that ethnic tensions in the West African nation have been additionally "manipulated by opportunist forces who are more interested in power than in national unity."
South African President Thabo Mbeki has been mandated by the AU and the Economic Community of West African States to visit the Ivorian capital of Abidjan and mediate the two-year-old civil war.
He is expected to bring Gbagbo and opposition leader Alassane Ouatarra to the negotiating table, along with Gabonese President Omar Bongo and the president of Burkina Faso, Blaise Compaore, both heads of state of neighbouring countries. Gbagbo has accused France of favouring the rebel forces and undermining his position ahead of elections in 2005.
''It is unfortunate and a grave miscalculation that Gbagbo's regime launched its surprise air raids in an attempt to retake the rebel-held north, which killed nine French soldiers and one American, violating the year-old ceasefire accord,'' says Kwame Akonor, executive director of the New York-based African Development Institute. He said it is not surprising that France's counterattack -- ''which included the destruction of Côte d'Ivoire's newly built-up air force and securing strategic control of the country's largest cities'' -- is raising concerns about the European power's real motives, ''given its chequered history and entrenched interests in its former colony''.
On Saturday, the 15-member Security Council condemned Côte d'Ivoire's fatal attack against French forces.
''The Security Council expresses its full support for the action undertaken by French forces and UNOCI,'' said a statement by U.S. Ambassador John Danforth, the council's current president.
France, a veto-wielding permanent member of the Security Council, is pushing for stronger action, including military sanctions and a travel ban on Côte d'Ivoire government officials.
A resolution calling for such measures is expected to be adopted before the end of this week. But it will give the two parties till Dec. 1 to implement the ceasefire and the peace agreement before coming into force.
Akonor said French concern over developments in its former colony is not simply politically motivated: Côte d'Ivoire has long been the key investment platform for French companies in West Africa.
France, he said, is Côte d'Ivoire's biggest single trading partner, defence supplier and bilateral aid donor. Paris also has military bases in the African country.
''Given its political, economic and military interests in the country, some genuinely wonder if France can function as a neutral peacekeeper,'' added Akonor.
This perception is not helped by the fact that French troops constitute 40 percent of the current U.N. peacekeeping force, and operate independently of it, he added.
''Anti-French sentiment was further stoked in Côte d'Ivoire when a dozen French peacekeepers were arrested and charged in September with stealing money from a local bank,'' said Akonor.
He suggested that if the U.N. deployment is to be credible and effective, ''then the composition of its force must reflect its principles of neutrality and impartiality''.
The Ivorian ambassador told reporters his government had requested an independent commission of inquiry to establish the facts of last weekend's attacks.
Asked if France was supporting rebel forces in Côte d'Ivoire, Djangone-Bi said that by its recent actions, Paris was obviously seen to be favouring the rebels.
He also accused France of ''rushing'' for urgent Security Council action and of dictating terms with its "powerful diplomacy."
''The house is not burning,'' said the ambassador. ''Give Africa a chance to resolve the problem." (END/2004)
http://www.ipsnews.net/new_nota.asp?idnews=26220
Thalif Deen
UNITED NATIONS, Nov 9 (IPS) - France is coming under fire for its heavy-handed action in destroying virtually the entire air force of its former colony Côte d'Ivoire in retaliation for the killings of nine French soldiers and a U.S. aid worker last week.
''We deeply regret the unfortunate incident,'' Ambassador Philippe Djangone-Bi of Côte d'Ivoire told reporters Tuesday. ''But France was wrong in its unilateral reprisal,'' he added.
He said his government wants the Security Council to make a pronouncement about ''our right as a sovereign nation.''
''We love France, it is a friendly country,'' said Djangone-Bi, but its troops had no right to ''fire at our presidential palace, destroy our forces, humiliate us, and shoot at our civilians from helicopters.''
Asked to respond, French Ambassador Jean-Marc de La Sabliere told reporters Tuesday the Ivorian Armed Forces carried out ''a deliberate attack'' on French troops.
''France had the right to retaliate. No one (in the Security Council) questioned us. This is not an issue,'' he added.
French President Jacques Chirac's decision to destroy the Ivorian Air Force was ''widely supported by the Security Council,'' de La Sabliere added.
As part of a combined French-U.N. peacekeeping force, Paris has more than 4,500 troops in Côte d'Ivoire, where a civil war has partitioned the territory into a government-held south and a rebel-held north.
The U.N. Operation in Côte d'Ivoire (UNOCI), created by the U.N. Security Council in April 2004, has a military strength of over 6,000 peacekeepers. But in an unusual arrangement, French troops have the right to act alone and do not come under the military authority of UNOCI.
The two forces are mandated to monitor a May 2003 cease-fire and peace agreement that was signed by the rebel forces and the government of President Laurent Gbagbo. ''The French should not be in Côte d'Ivoire'', says Bill Fletcher Jr, executive director of Washington-based TransAfrica Forum.
''There should be either a United Nations force or an African Union (AU) force. The French clearly have an interest in retaining their role as the hegemonic power over their former colonies,'' Fletcher told IPS.
Côte d'Ivoire gained independence from France in 1960.
Fletcher also argued that ethnic tensions in the West African nation have been additionally "manipulated by opportunist forces who are more interested in power than in national unity."
South African President Thabo Mbeki has been mandated by the AU and the Economic Community of West African States to visit the Ivorian capital of Abidjan and mediate the two-year-old civil war.
He is expected to bring Gbagbo and opposition leader Alassane Ouatarra to the negotiating table, along with Gabonese President Omar Bongo and the president of Burkina Faso, Blaise Compaore, both heads of state of neighbouring countries. Gbagbo has accused France of favouring the rebel forces and undermining his position ahead of elections in 2005.
''It is unfortunate and a grave miscalculation that Gbagbo's regime launched its surprise air raids in an attempt to retake the rebel-held north, which killed nine French soldiers and one American, violating the year-old ceasefire accord,'' says Kwame Akonor, executive director of the New York-based African Development Institute. He said it is not surprising that France's counterattack -- ''which included the destruction of Côte d'Ivoire's newly built-up air force and securing strategic control of the country's largest cities'' -- is raising concerns about the European power's real motives, ''given its chequered history and entrenched interests in its former colony''.
On Saturday, the 15-member Security Council condemned Côte d'Ivoire's fatal attack against French forces.
''The Security Council expresses its full support for the action undertaken by French forces and UNOCI,'' said a statement by U.S. Ambassador John Danforth, the council's current president.
France, a veto-wielding permanent member of the Security Council, is pushing for stronger action, including military sanctions and a travel ban on Côte d'Ivoire government officials.
A resolution calling for such measures is expected to be adopted before the end of this week. But it will give the two parties till Dec. 1 to implement the ceasefire and the peace agreement before coming into force.
Akonor said French concern over developments in its former colony is not simply politically motivated: Côte d'Ivoire has long been the key investment platform for French companies in West Africa.
France, he said, is Côte d'Ivoire's biggest single trading partner, defence supplier and bilateral aid donor. Paris also has military bases in the African country.
''Given its political, economic and military interests in the country, some genuinely wonder if France can function as a neutral peacekeeper,'' added Akonor.
This perception is not helped by the fact that French troops constitute 40 percent of the current U.N. peacekeeping force, and operate independently of it, he added.
''Anti-French sentiment was further stoked in Côte d'Ivoire when a dozen French peacekeepers were arrested and charged in September with stealing money from a local bank,'' said Akonor.
He suggested that if the U.N. deployment is to be credible and effective, ''then the composition of its force must reflect its principles of neutrality and impartiality''.
The Ivorian ambassador told reporters his government had requested an independent commission of inquiry to establish the facts of last weekend's attacks.
Asked if France was supporting rebel forces in Côte d'Ivoire, Djangone-Bi said that by its recent actions, Paris was obviously seen to be favouring the rebels.
He also accused France of ''rushing'' for urgent Security Council action and of dictating terms with its "powerful diplomacy."
''The house is not burning,'' said the ambassador. ''Give Africa a chance to resolve the problem." (END/2004)
http://www.ipsnews.net/new_nota.asp?idnews=26220
Tuesday, November 09, 2004
New York Times: Informal Lenders in China Pose Risks to Banking System
Informal Lenders in China Pose Risks to Banking System
By KEITH BRADSHER
By KEITH BRADSHER
WENZHOU, China, Nov. 3 - The Wenzhou "stir-fry" is not a dish you eat. But it is giving indigestion to Chinese regulators and could prove troublesome to many investors worldwide - from New York money managers, Pennsylvania steel workers and Midwestern farmers to miners in Australia.
Here in this freewheeling city at the forefront of capitalism in China, the dish is prepared when a group of wealthy friends pool millions of dollars worth of Chinese yuan and put it into a hot investment like Shanghai real estate, where it is stirred and flipped for a hefty profit.
The friends often lend each other large amounts on the strength of a handshake and a handwritten i.o.u. Both sides then go to an automated teller machine or bank branch to transfer the money, which is then withdrawn from the bank. Or sometimes they do it the old-fashioned way: exchanging burlap sacks stuffed with cash.
The worry for Chinese regulators is that everyone in China will start cooking the Wenzhou stir-fry and do it outside the banking system. In the last few months, borrowing and lending across the rest of China is looking more and more like Wenzhou's. The growth of this shadow banking system poses a stiff challenge to China's state-owned banks, already burdened with bad debt, and makes it harder for the nation's leaders to steer a fast-growing economy.
The problem starts with China's low interest rates. More and more families with savings have been snubbing 2 percent interest on bank deposits for the double-digit returns from lending large amounts on their own. They lend to real estate speculators or to small businesses without the political connections to obtain loans from the banks. Not only is the informal lending rate higher, but the income from that lending, because it is semilegal at best, is not taxed. For fear of shame, ostracism and the occasional threat from thugs, borrowers are more likely to pay back these loans than those from the big banks.
Tao Dong, chief China economist at Credit Suisse First Boston, calculates that Chinese citizens withdrew $12 billion to $17 billion from their bank deposits in August and September. The outflow turned into a flood last month, reaching an estimated $120 billion, or more than 3 percent of all deposits at the country's financial institutions.
If the bank withdrawals are not stemmed in the months ahead, Mr. Tao warned, "this potentially could be a huge risk for financial stability and even social stability."
With China now accounting for more than a quarter of the world's steel production and nearly a fifth of soybean production, as well as some of the largest initial public offerings of stock, any shaking of financial confidence here could ripple quickly through markets in the United States and elsewhere. For instance, if the steel girders now being lifted into place by hundreds of tall cranes in big cities across China are no longer needed, that would produce a worldwide glut of steel and push down prices.
On Oct. 28, when China's central bank raised interest rates for one-year loans and deposits by a little more than a quarter of a percentage point, it cited a need to keep money in the banking system. Higher official rates should "reduce external cycling of credit funds," the bank said in a statement.
The main Chinese banks have fairly substantial reserves, but they need those reserves to cover huge write-offs of bad debts someday. The International Monetary Fund's China division chief, Eswar Prasad, expressed concern about bank withdrawals in a speech in Hong Kong three days before the central bank acted.
The hub of informal lending in China is here in Wenzhou, 230 miles south of Shanghai. Some of China's first experiments with the free market began here in the late 1970's, and a result has been a flourishing economy together with sometimes questionable business dealings.
Depending on how raw they like their capitalism, people elsewhere in China describe Wenzhou as either a center of financial innovation or a den of loan sharks. But increasingly, Wenzhou is also a microcosm of the kind of large-scale yet informal financial dealings now going on across the country.
The withdrawals by depositors and the informal money lending have spread so swiftly here that it is only in Wenzhou that the Chinese central bank releases monthly statistics on average rates for direct loans between individuals or companies. The rate hovered at 1 percent a month for years until April, when the authorities began limiting the volume of bank loans.
Borrowers default on nearly half the loans issued by the state-owned banks, but seldom do so here on money that is usually borrowed from relatives, neighbors or people in the same industry. Residents insist that the risk of ostracism for failing to repay a loan is penalty enough to ensure repayment of most loans.
Although judges have ruled that handwritten i.o.u.'s are legally binding, creditors seldom go to court to collect. "If it is a really good friend, I would lose face if I sued them in court," said Tu Shangyun, the owner of a local copper smelter and part-time "silver bearer" - a broker who puts lenders and borrowers in touch with each other, "and if it weren't a good friend, I wouldn't lend the money in the first place."
Violence is extremely rare, but the threat of it does exist as the ultimate guarantor that people make every effort to repay debts. "Someone can hire a killer who will chase you down, beat you up and maybe even kill you," said Ma Jinlong, who oversaw market-driven financial changes in the 1990's in Wenzhou as director of the municipal economic reform committee and is now an economics professor at Wenzhou University.
An austerity policy was invoked, its goal to slow rapid economic growth in the hope of stopping an upward spiral in the inflation rate. With consumer prices rising at 5.2 percent a year despite price controls on many goods and services, and with less-regulated prices for goods traded between companies climbing nearly twice as fast, people lose buying power while their money is on deposit at a bank.
The interest rate for informal loans jumped last spring to 1.2 percent a month, or 15.4 percent compounded over a year, and has stayed there since. According to the nation's central bank, total bank deposits in Wenzhou have been dropping by $250 million a month since April as companies and individuals withdraw money either because they can no longer obtain bank loans for their investments or because they want to lend the money at higher rates to each other.
For lenders, these interest rates are much more attractive than earning a meager 2.25 percent a year, even after the recent rate increase, on a deposit at a government-owned bank. And while Beijing assesses a 20 percent tax on all interest from bank deposits, nobody pays tax on the income they receive from lending money on their own, Mr. Ma said.
Most informal loans have traditionally gone to relatives or neighbors to finance the starting of small local businesses. Wenzhou is now one of the world's largest producers of nonbrand sunglasses; Dong Ganming, the owner of a 350-employee sunglass factory here, said that his plant was just one of almost 1,000 here involved in making glasses.
Fierce competition has prompted local residents to borrow money to exploit every possible niche in the industry, with some factories making nothing but bridges for sunglasses so that they will not slide down customers' noses, other factories making only the lenses and so forth. Any government crackdown on informal loans would carry the risk of stifling highly efficient small and medium-size businesses that have little hope of obtaining loans from the state-owned banks, which still allocate credit based partly on political connections.
Mr. Dong said that loans from friends and family allowed him to start his sunglass company with 10 employees a decade ago; he quickly paid off the loans and has been reinvesting most of the profit ever since, putting very little into bank deposits. "The interest in the bank is very low," he said. "If you invest the money, you can get much more money."
But more recently, local residents say, a lot of money has been flowing into real estate here and in other big cities, especially Shanghai, helping to fuel double-digit increases in interest rates. Deals increasingly involve people who have no family or neighborhood connection, raising the risk of disputes.
Kellee Tsai, a specialist in Chinese informal banking at Johns Hopkins University, said that many overseas emigrants from Wenzhou had also been sending their savings back to be lent at much higher rates here than are available in the countries they have moved to.
Some local investors have been able to pay for their investments with profits from businesses here, like Chen Shen, the owner of four shops that sell shoe-manufacturing equipment to the hundreds of shoe factories that have popped up in this area. She said she paid cash for an apartment near Shanghai's Bund, its riverfront district, that had appreciated as much as 60 percent in less than two years.
Still, Chinese regulators do not like the practice, and officials have been trying to stamp out such operations with limited success. They have outlawed the practice of pooling savings into various kinds of informal banks that make loans for real estate and other investments: organizers are subject to the death penalty but are rarely caught unless the informal banks collapse.
Oriental Outlook, a Chinese current affairs magazine, reported late last month on the trial of a man accused of operating an illegal bank northeast of here that collapsed a year ago, leading to the filing of more than 200 civil suits. Another man who lost money in the scheme, and went bankrupt as a result, assaulted the defendant outside the courtroom, the magazine said.
The extent of such pooling is unclear. But it poses the greatest risks of damage to financial confidence if bank runs occur at these informal institutions, economists agree. Bank runs, with depositors lined up clamoring for their money back, have been an occasional problem around China for years, but always quickly contained as the authorities rushed to distribute as much cash as necessary.
"The policy with bank runs, even with illegal banks in some cases, has been to flood the bank with liquidity and pay everyone off," said Michael Pettis, a finance professor at Beijing University, who criticized as ill advised the Chinese policy of bailing out even illegal banks. "One of the most salutary ways to let people know not to put money in these is to let two or three go bankrupt."
TimesOnline: Plane passengers shocked by their x-ray scans
Plane passengers shocked by their x-ray scans
Dipesh Gadher,Transport Correspondent
AN X-RAY machine that sees through air passengers’ clothes has been deployed by security staff at London’s Heathrow airport for the first time.
The device at Terminal 4 produces a “naked” image of passengers by bouncing X-rays off their skin, enabling staff instantly to spot any hidden weapons or explosives.
But the graphic nature of the black and white images it generates — including revealing outlines of men and women — has raised concerns about privacy both among travellers and aviation authorities.
In America, transport officials are refusing to deploy the device until it can be further refined to “mask” passengers’ modesty.
The Terminal 4 trial — being conducted jointly by the British Airports Authority and the Department for Transport — became fully operational last month and is intended to run until the end of the year. Its deployment has not been reported until now since new security measures at airports are not normally publicised.
If the new body scanner is able to cope with large volumes of passengers, improves detection rates and, crucially, receives public acceptance, it is likely to be rolled out across all Britain’s airports.
At Heathrow, passengers are picked to go through the body scanner on a random and voluntary basis. Those who refuse are subjected to an automatic hand search.
The scanner, which resembles a tall, grey filing cabinet, operates in a curtained area and passengers are asked to stand in front of it, adopting several poses, for their “naked” image to be registered. Once checked, the images are immediately erased.
Security officials claim it is a far more effective way of countering potential terrorists because it detects the outline of any solid object — such as plastic explosives or ceramic knives — which conventional metal detectors would miss.
Managers at Heathrow also say the new technology does away with the need to subject passengers to potentially intrusive hand searches. However, travellers who have been screened — and have asked to see the images — have been surprised by their clarity.
“I was quite shocked by what I saw,” said Gary Cook, 40, a graphic designer from Shaftesbury, Dorset. “I felt a bit embarrassed looking at the image.
A female passenger, who did not want to be named, said: “It was really horrible. It doesn’t leave much to the imagination because you’re virtually naked, but I guess it’s less intrusive than being hand searched.”
In a similar trial at Orlando international airport in Florida in 2002, passengers were shown a dummy image before going through, and at least a quarter of them refused to volunteer.
In America last year, Susan Hallowell, director of the US Transportation Security Administration’s (TSA) security laboratory, showed off her own x-ray image to demonstrate the technology to reporters.
“It basically makes you look fat and naked, but you see all this stuff,” said Hallowell, who had deliberately hidden a gun and a bomb under her clothes.
The TSA has decided not to deploy the device at American airports until manufacturers can develop an electronic means of masking sensitive body parts.
Dipesh Gadher,Transport Correspondent
AN X-RAY machine that sees through air passengers’ clothes has been deployed by security staff at London’s Heathrow airport for the first time.
The device at Terminal 4 produces a “naked” image of passengers by bouncing X-rays off their skin, enabling staff instantly to spot any hidden weapons or explosives.
But the graphic nature of the black and white images it generates — including revealing outlines of men and women — has raised concerns about privacy both among travellers and aviation authorities.
In America, transport officials are refusing to deploy the device until it can be further refined to “mask” passengers’ modesty.
The Terminal 4 trial — being conducted jointly by the British Airports Authority and the Department for Transport — became fully operational last month and is intended to run until the end of the year. Its deployment has not been reported until now since new security measures at airports are not normally publicised.
If the new body scanner is able to cope with large volumes of passengers, improves detection rates and, crucially, receives public acceptance, it is likely to be rolled out across all Britain’s airports.
At Heathrow, passengers are picked to go through the body scanner on a random and voluntary basis. Those who refuse are subjected to an automatic hand search.
The scanner, which resembles a tall, grey filing cabinet, operates in a curtained area and passengers are asked to stand in front of it, adopting several poses, for their “naked” image to be registered. Once checked, the images are immediately erased.
Security officials claim it is a far more effective way of countering potential terrorists because it detects the outline of any solid object — such as plastic explosives or ceramic knives — which conventional metal detectors would miss.
Managers at Heathrow also say the new technology does away with the need to subject passengers to potentially intrusive hand searches. However, travellers who have been screened — and have asked to see the images — have been surprised by their clarity.
“I was quite shocked by what I saw,” said Gary Cook, 40, a graphic designer from Shaftesbury, Dorset. “I felt a bit embarrassed looking at the image.
A female passenger, who did not want to be named, said: “It was really horrible. It doesn’t leave much to the imagination because you’re virtually naked, but I guess it’s less intrusive than being hand searched.”
In a similar trial at Orlando international airport in Florida in 2002, passengers were shown a dummy image before going through, and at least a quarter of them refused to volunteer.
In America last year, Susan Hallowell, director of the US Transportation Security Administration’s (TSA) security laboratory, showed off her own x-ray image to demonstrate the technology to reporters.
“It basically makes you look fat and naked, but you see all this stuff,” said Hallowell, who had deliberately hidden a gun and a bomb under her clothes.
The TSA has decided not to deploy the device at American airports until manufacturers can develop an electronic means of masking sensitive body parts.
Bloomberg Asian Analyst Andy Mukherjee: Can Asia Dump Bretton Woods II as Dollar Falls
Can Asia Dump Bretton Woods II as Dollar Falls? by Andy Mukherjee
Bloomberg
Nov. 9 (Bloomberg) -- President George W. Bush's second term may be a challenging time for Asian central bankers.
With the dollar hitting an all-time low against the euro yesterday, traders are betting that Bush may add to the $412.6 billion U.S. budget deficit, increasing the pressure on the dollar to decline. And unlike during the last three years, the brunt of the dollar's fall may not be borne by Europe alone.
Bank of America Corp. says China may allow its currency to fluctuate in a wider range as early as the first quarter of 2005. Together, the two factors -- record current account and budget deficits in the U.S. and a possible appreciation in the yuan --may lead to stronger Asian currencies next year.
The adjustment could mean an end to the current system of semi-fixed Asian exchange rates that has been termed the ``Revived Bretton Woods,'' by Michael Dooley of University of California at Santa Cruz, David Folkerts-Landau, Deutsche Bank AG's head of research, and Peter Garber, the bank's strategist.
Revived Bretton Woods, or ``Bretton Woods II,'' is supposed to be a re-embodiment of the Bretton Woods arrangement, a post World War II system in which the U.S. was obliged to pay gold at $35 an ounce to its official foreign creditors. Other countries pegged their currencies to the dollar.
Whereas the original Bretton Woods system collapsed in 1973, its replacement is seen as an ongoing and mutually beneficial agreement between the U.S., which is the world's financial ``core'' and Asia, which is its ``periphery.'' The periphery is allowed to expand its exports by keeping its currencies cheap, as long as it supplies capital to the core to pay for its spending excesses.
Bretton Woods II
As Dooley and the Deutsche economists pointed out in their paper last year, ``Exporting to the U.S. is Asia's main concern. Exports means growth. When their imports do not keep up, the official sectors are happy to buy U.S. securities. Their appetite for such investments is, for all practical purposes, unlimited because their growth capacity is far from its limit.''
At the heart of Bretton Woods II is China's 200 million underemployed rural population. ``And even if this reserve of labor was gone,'' the authors say, ``India is ready to graduate to the periphery with its vast supply of underemployed workers.''
If it's in the interest of Asian central bankers to keep a lid on their home currencies until every surplus worker in rural China and India has found a job in an export factory, then why should there be a change in Asia's currency policy in the next four years of Bush's presidency?
Weak Dollar
There are strong reasons. On the U.S. side, the issue is political. Jobs are at stake. A weak dollar is ``ultimately what the economy needs,'' says Bill Gross, the chief investment officer at Pacific Investment Management Co. in Newport Beach, California. On the Asian side, the reason why the region must now choose to live with higher currencies is inflation. By increasing interest rates for the first time in nine years, China has sent a signal that it's taking inflation seriously.
Yet, if the People's Bank of China increases domestic interest rates significantly -- and keeps the currency pegged at 8.3 to the dollar -- it will invite more speculative capital into the country, aggravating inflation.
There's another important reason why Bretton Woods II may have to be dumped. Nouriel Roubini, a professor of economics at New York University's Stern School of Business, says that the current global financial system can be sustained only if Asian central banks act as a cartel and keep their existing and future reserves in U.S. dollars.
There is, however, no formal cartel. As a result, every Asian central bank will want to protect itself against an erosion in the value of its assets from a decline in the dollar.
Tragedy of Commons
In other words, what's in the interest of one Asian central bank isn't for all. Social scientists have a name for this phenomenon: ``Tragedy of the Commons.''
``All central banks may be better off if no bank tries to diversify its reserve holdings,'' Roubini says, ``but as the risks of dollar depreciation grows, each central bank has an incentive to defect and to try to protect itself from losses.''
Losses could indeed be large. Asian central banks own more than $2.2 trillion in foreign-exchange reserves out of a global total of $3.4 trillion. At the end of last year, almost 64 percent of central bank reserves globally were denominated in U.S. dollars, according to the International Monetary Fund.
As Asia tries to diversify out of the dollar, the U.S. currency may decline further. An individual central bank ``can only protect itself if it either shifts out of dollars and into euros ahead of the others, or buys a euro/dollar hedge before everyone else,'' Roubini says.
Adjustments will be painful. Still, it would be better for everyone concerned to end the Bretton Woods II agreement now before it's too late for both the U.S. consumer and the Asian exporter.
To contact the writer of this column:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net.
Bloomberg: Philippine Debt Ratings May Be Lowered by Moody's as Tax Increases Held Up
Philippine Debt Ratings May Be Lowered by Moody's as Tax Increases Held Up
Nov. 9 (Bloomberg) -- The Philippines' credit rating may be cut by Moody's Investors Service on concern President Gloria Arroyo will fail to get lawmakers to pass tax increases needed to narrow the nation's budget deficit.
The ratings are on review for possible downgrade ``due to concerns over the sustainability of the government's fiscal and debt positions,'' the company said in a statement released in Hong Kong. Moody's foreign- and local-currency ratings for the Philippines are Ba2, two levels below investment grade and on a par with Fiji and Bulgaria.
Arroyo is seeking to end a run of deficits since 1998 that bloated national debt to 3.54 trillion pesos ($63 billion) in June, 19 percent higher than a year earlier. Credit rating cuts have made it more expensive for the government to borrow and caused the peso to slump, making it harder to meet debt payments.
``This is the price we have to pay for the slow passage of needed tax reform,'' said Jun Mendoza, who helps manage about $1.3 billion at Banco de Oro, a Manila-based lender.
Arroyo, who won a May election, submitted an eight-part tax package to Congress in July, saying it would boost annual revenue by 80 billion pesos. A bill raising cigarette and liquor taxes by an estimated 7.6 billion pesos, less than the 19 billion pesos sought in the package, has been passed by the House of Representatives for approval in the Senate.
Stocks Drop
``Attempts by the government to pass into legislation urgently needed revenue measures are proving to be politically difficult,'' Moody's said in today's statement. The ratings company has had a negative outlook on all of the Philippines' long-term ratings since they were cut in January.
The Philippine key stock index posted its biggest drop in two weeks after today's announcement, sliding 1.3 percent to 1789.03 at the noon close in Manila.
The yield gap between the Philippines' 8.25 percent bond due in 2014 and similar-maturity U.S. Treasuries widened to 4.68 percentage points at 11:00 a.m. in Manila after the Moody's announcement, according to HSBC Treasury & Capital Markets. The spread was 4.61 points yesterday and narrowed to as little as 3.82 points in April.
Banco de Oro's Mendoza said he isn't buying the nation's 10- year dollar bonds, forecast the yield spread would widen 20 basis points more this week. A basis point is 0.01 percentage point.
``After months of wrangling, we still do not have clarity on if and when the tax measures will be passed or, if passed, whether they would be watered down.'' Said John Teng, a fixed- income analyst at Nomura International (Hong Kong) Ltd.
Lower Ratings
Standard & Poor's said on Oct. 7 it may lower the outlook on its debt rating for the Philippines unless tax increases are approved this year. Fitch Ratings may announce a change to the nation's BB debt rating this month, according to Brian Coulton, the company's Hong Kong-based head of sovereign ratings for Asia. Like Moody's both companies have Philippine ratings that are two rungs below investment grade.
``We are looking at the fiscal adjustments, whether we will see significant tax measures implemented in 2005,'' Coulton said. The government should approve increases in taxes on oil, cigarettes and beer, and raise value-added taxes, he said.
Finance Secretary Juanita Amatong, speaking from her car en route to a meeting with the Senate Ways and Means Committee, said the government expects to have some of its proposed tax changes approved this year.
Opposition
The legislators ``are double-timing but it is a democratic country, of course there will be opposition,'' she said. ``We are talking to the different stakeholders.''
Moody's review will take place in Manila and begin on Dec. 1, according to Corazon Guidote, the government's investor relations' officer. A rating cut may force the Philippines to borrow less than planned from abroad and increase domestic bond sales, Finance Undersecretary Eric Recto said.
The nation, which uses a third of government spending to pay interest, plans to borrow $3 billion to $3.1 billion abroad next year to fund the 2005 budget deficit and to lend to National Power Corp., the country's unprofitable state-owned power monopoly, Finance Undersecretary Eric Recto said.
``We will have to deal with it if a downgrade happens,'' he said.
The Philippine budget deficit was 141.9 billion pesos in the first nine months of the year, 72 percent of the government's full-year forecast. The shortfall reached a record 211 billion pesos in 2002 and the government, which said it doesn't expect a balanced budget before 2009, forecast a 198 billion pesos gap for this year.
The Philippines is the only Asian nation to have had its debt rating cut over the past two years. Ratings have been raised in eight other countries, including Malaysia, India and Indonesia.
To contact the reporter for this story:
Jun Ebias in Manila jebias@bloomberg.net
Nov. 9 (Bloomberg) -- The Philippines' credit rating may be cut by Moody's Investors Service on concern President Gloria Arroyo will fail to get lawmakers to pass tax increases needed to narrow the nation's budget deficit.
The ratings are on review for possible downgrade ``due to concerns over the sustainability of the government's fiscal and debt positions,'' the company said in a statement released in Hong Kong. Moody's foreign- and local-currency ratings for the Philippines are Ba2, two levels below investment grade and on a par with Fiji and Bulgaria.
Arroyo is seeking to end a run of deficits since 1998 that bloated national debt to 3.54 trillion pesos ($63 billion) in June, 19 percent higher than a year earlier. Credit rating cuts have made it more expensive for the government to borrow and caused the peso to slump, making it harder to meet debt payments.
``This is the price we have to pay for the slow passage of needed tax reform,'' said Jun Mendoza, who helps manage about $1.3 billion at Banco de Oro, a Manila-based lender.
Arroyo, who won a May election, submitted an eight-part tax package to Congress in July, saying it would boost annual revenue by 80 billion pesos. A bill raising cigarette and liquor taxes by an estimated 7.6 billion pesos, less than the 19 billion pesos sought in the package, has been passed by the House of Representatives for approval in the Senate.
Stocks Drop
``Attempts by the government to pass into legislation urgently needed revenue measures are proving to be politically difficult,'' Moody's said in today's statement. The ratings company has had a negative outlook on all of the Philippines' long-term ratings since they were cut in January.
The Philippine key stock index posted its biggest drop in two weeks after today's announcement, sliding 1.3 percent to 1789.03 at the noon close in Manila.
The yield gap between the Philippines' 8.25 percent bond due in 2014 and similar-maturity U.S. Treasuries widened to 4.68 percentage points at 11:00 a.m. in Manila after the Moody's announcement, according to HSBC Treasury & Capital Markets. The spread was 4.61 points yesterday and narrowed to as little as 3.82 points in April.
Banco de Oro's Mendoza said he isn't buying the nation's 10- year dollar bonds, forecast the yield spread would widen 20 basis points more this week. A basis point is 0.01 percentage point.
``After months of wrangling, we still do not have clarity on if and when the tax measures will be passed or, if passed, whether they would be watered down.'' Said John Teng, a fixed- income analyst at Nomura International (Hong Kong) Ltd.
Lower Ratings
Standard & Poor's said on Oct. 7 it may lower the outlook on its debt rating for the Philippines unless tax increases are approved this year. Fitch Ratings may announce a change to the nation's BB debt rating this month, according to Brian Coulton, the company's Hong Kong-based head of sovereign ratings for Asia. Like Moody's both companies have Philippine ratings that are two rungs below investment grade.
``We are looking at the fiscal adjustments, whether we will see significant tax measures implemented in 2005,'' Coulton said. The government should approve increases in taxes on oil, cigarettes and beer, and raise value-added taxes, he said.
Finance Secretary Juanita Amatong, speaking from her car en route to a meeting with the Senate Ways and Means Committee, said the government expects to have some of its proposed tax changes approved this year.
Opposition
The legislators ``are double-timing but it is a democratic country, of course there will be opposition,'' she said. ``We are talking to the different stakeholders.''
Moody's review will take place in Manila and begin on Dec. 1, according to Corazon Guidote, the government's investor relations' officer. A rating cut may force the Philippines to borrow less than planned from abroad and increase domestic bond sales, Finance Undersecretary Eric Recto said.
The nation, which uses a third of government spending to pay interest, plans to borrow $3 billion to $3.1 billion abroad next year to fund the 2005 budget deficit and to lend to National Power Corp., the country's unprofitable state-owned power monopoly, Finance Undersecretary Eric Recto said.
``We will have to deal with it if a downgrade happens,'' he said.
The Philippine budget deficit was 141.9 billion pesos in the first nine months of the year, 72 percent of the government's full-year forecast. The shortfall reached a record 211 billion pesos in 2002 and the government, which said it doesn't expect a balanced budget before 2009, forecast a 198 billion pesos gap for this year.
The Philippines is the only Asian nation to have had its debt rating cut over the past two years. Ratings have been raised in eight other countries, including Malaysia, India and Indonesia.
To contact the reporter for this story:
Jun Ebias in Manila jebias@bloomberg.net
The Economist: America’s privilege, the world’s worry
America’s privilege, the world’s worry
Nov 8th 2004
From The Economist Global Agenda
The dollar plumbed new depths against the euro this week. The greenback’s fall has unnerved European policymakers. But it is their Asian counterparts who have most reason to worry
CHARLES DE GAULLE, founder of France’s fifth republic, famously resented America’s paramount position in the global economy of the 1960s. The United States, he complained, enjoyed an “exorbitant privilege”. Because its currency, the dollar, served as the world’s reserve asset, America could live beyond its means, unconstrained by the periodic shortages of foreign exchange that haunted other, less privileged nations. Nicolas Sarkozy, France’s spirited finance minister, wants to inherit de Gaulle’s mantle as president of the fifth republic. Though somewhat smaller in stature than the great general, both physically and politically, Mr Sarkozy seems to share his outsized resentment of America’s economic privileges.
Mr Sarkozy has more to envy than de Gaulle ever had. Today’s America lives beyond its means more flagrantly than ever before. Its government will spend about $427 billion more than it raises in taxes this year. The nation as a whole is running a deficit of $571.9 billion on its current account with the rest of the world. These twin deficits, Mr Sarkozy points out, weigh heavily on the dollar. The currency’s fall, interrupted in February, has resumed (see chart). On Monday November 8th, it plumbed a new low against the euro of a whisker under $1.30. Only if America restrains its deficits will the markets regain confidence in the dollar, Mr Sarkozy warned. “This is a unanimous message from the Europeans and the International Monetary Fund that we send to the United States.”
Mr Sarkozy no doubt fears that his American counterparts are quite happy to watch the dollar fall. Their professed commitment to a “strong dollar policy” might disguise a policy of benign neglect. America’s net overseas liabilities amounted to 23% of GDP at the end of last year, close to the record debts it amassed in 1894, according to Ken Rogoff and Maurice Obstfeld of the National Bureau of Economic Research. Crucially, the bulk of these debts are denominated in dollars. Thus America may be sorely tempted to dishonour its dollar debts, not by defaulting on them, but by devaluing them.
The immediate casualties of such a policy would be America’s East Asian creditors. By the end of last year, Asian central banks held $1.89 trillion of foreign reserves, the vast bulk of them in dollars. If these reserves lost value, Asian economies would suffer an almighty capital loss in domestic-currency terms. A recent study by the New York Federal Reserve counted the costs. If the Chinese yuan were to appreciate by 10% against the dollar (and other reserve currencies), China would suffer a capital loss worth almost 3% of GDP, the study found. If the won rose by 10%, South Korea would suffer similarly. The toll would be even greater in Singapore (10% of GDP) and Taiwan (8%).
To avert such an appreciation, Asian central banks would have to amass ever greater holdings of dollars. But this would only expose them to greater capital losses down the road. Alternatively, they might seek to avoid the consequences of a dollar fall, by diversifying into other reserve currencies, such as the euro. But that would only bring the dollar crashing down all the more quickly. In other words, Asian central banks are caught in an awkward dilemma: either they try to break the dollar’s fall, or they try to escape from underneath its collapse.
Despite this dilemma, Asia’s central bankers created less of a fuss on Monday than Europe’s did. Jean-Claude Trichet, president of the European Central Bank (ECB), described the dollar’s fall against the euro as unwelcome and “brutal”, repeating the melodramatic language he adopted in January. Why the worry? In some ways, the stronger euro will do Mr Trichet’s job for him. It will contain euro-area inflation, which has remained stubbornly above the ECB’s ceiling of 2%. It will offset the higher dollar price of oil—last month’s worry du jour. And if the euros in their pockets gain in value, European households might be more willing to spend them, overcoming the caution that has held the European recovery back for much of this year.
It is true that the dollar has never been weaker against Europe’s single currency since its birth in 1999. But as recently as 1997 it was weaker against a basket of the 12 currencies out of which the euro was fashioned. Back then, no one described the dollar’s movements as brutal. Indeed, at times it seems that European resentment of America’s privileges is a little exorbitant.
Mr Sarkozy has more to envy than de Gaulle ever had. Today’s America lives beyond its means more flagrantly than ever before. Its government will spend about $427 billion more than it raises in taxes this year. The nation as a whole is running a deficit of $571.9 billion on its current account with the rest of the world. These twin deficits, Mr Sarkozy points out, weigh heavily on the dollar. The currency’s fall, interrupted in February, has resumed (see chart). On Monday November 8th, it plumbed a new low against the euro of a whisker under $1.30. Only if America restrains its deficits will the markets regain confidence in the dollar, Mr Sarkozy warned. “This is a unanimous message from the Europeans and the International Monetary Fund that we send to the United States.”
Mr Sarkozy no doubt fears that his American counterparts are quite happy to watch the dollar fall. Their professed commitment to a “strong dollar policy” might disguise a policy of benign neglect. America’s net overseas liabilities amounted to 23% of GDP at the end of last year, close to the record debts it amassed in 1894, according to Ken Rogoff and Maurice Obstfeld of the National Bureau of Economic Research. Crucially, the bulk of these debts are denominated in dollars. Thus America may be sorely tempted to dishonour its dollar debts, not by defaulting on them, but by devaluing them.
The immediate casualties of such a policy would be America’s East Asian creditors. By the end of last year, Asian central banks held $1.89 trillion of foreign reserves, the vast bulk of them in dollars. If these reserves lost value, Asian economies would suffer an almighty capital loss in domestic-currency terms. A recent study by the New York Federal Reserve counted the costs. If the Chinese yuan were to appreciate by 10% against the dollar (and other reserve currencies), China would suffer a capital loss worth almost 3% of GDP, the study found. If the won rose by 10%, South Korea would suffer similarly. The toll would be even greater in Singapore (10% of GDP) and Taiwan (8%).
To avert such an appreciation, Asian central banks would have to amass ever greater holdings of dollars. But this would only expose them to greater capital losses down the road. Alternatively, they might seek to avoid the consequences of a dollar fall, by diversifying into other reserve currencies, such as the euro. But that would only bring the dollar crashing down all the more quickly. In other words, Asian central banks are caught in an awkward dilemma: either they try to break the dollar’s fall, or they try to escape from underneath its collapse.
Despite this dilemma, Asia’s central bankers created less of a fuss on Monday than Europe’s did. Jean-Claude Trichet, president of the European Central Bank (ECB), described the dollar’s fall against the euro as unwelcome and “brutal”, repeating the melodramatic language he adopted in January. Why the worry? In some ways, the stronger euro will do Mr Trichet’s job for him. It will contain euro-area inflation, which has remained stubbornly above the ECB’s ceiling of 2%. It will offset the higher dollar price of oil—last month’s worry du jour. And if the euros in their pockets gain in value, European households might be more willing to spend them, overcoming the caution that has held the European recovery back for much of this year.
It is true that the dollar has never been weaker against Europe’s single currency since its birth in 1999. But as recently as 1997 it was weaker against a basket of the 12 currencies out of which the euro was fashioned. Back then, no one described the dollar’s movements as brutal. Indeed, at times it seems that European resentment of America’s privileges is a little exorbitant.
Daily Telegraph: When a taste for the exotic is plain good sense
When a taste for the exotic is plain good sense
Daily Telegraph
Daily Telegraph
The risks are real but bonds issued by developing countries may be more rewarding than you think, says Robert Miller
Rising interest rates are usually bad news for bondholders, because it makes the fixed interest or "coupon" they pay relatively less attractive.
But, despite last week's interest rate rise in China - the first in nine years - investors in emerging market bond funds have generally been rewarded for accepting high risks in recent years. The average return from this sector has been nearly double the average from all types of pooled fund over the past five years.
Although their outperformance has been more marginal over the past year, these funds have tended to benefit from investors' worst fears not being realised by subsequent events. Even so, this is not an investment sector for widows and orphans. Emerging market finance ministers at last month's annual meetings of the World Bank and International Monetary Fund (IMF) in Washington made outspoken verbal assaults on the greed of the world's richest nations, demonstrating that investors in their bonds need strong nerves.
In this instance, bonds are IOUs issued by the governments of developing countries. Taken at face value, many of the ministers' attacks appear to convey the threat of government debt defaults - refusal to pay interest or capital - as happened most recently in Argentina.
"There's always a bad news story somewhere," says Paul Murray-John, the manager of the £86m Threadneedle Emerging Market Bond fund, who attended the meetings. "But investors must look beyond what is in large part political posturing and point scoring for a domestic audience. If you study the investment fundamentals which underpin emerging market sovereign [government] bonds it is quite another story."
Mr Murray-John, whose investments include bonds issued by the governments of Brazil, Turkey, Bulgaria, Venezuela and Russia, adds: "These emerging market countries need the foreign money raised on the international bond markets to help their domestic economies grow. They talk tough but actually work very hard to make sure they meet the requirements on financial reporting, timely debt repayments and other governance issues laid down by authorities such as the IMF."
The Threadneedle manager, who has run the fund since its launch in 1997 with Russian-born Igor Ojereliev as his deputy, concedes that for many investors, and particularly risk-averse ones, putting money in emerging market bonds, even if they are issued by governments rather than companies, is a big step.
"But what is the alternative?" he asks. "In the past, UK gilts - bonds issued by the British Government - have yielded enough to meet the requirements of the most risk-averse investors. That is no longer the case. I would argue strongly that if you want to take risks with your portfolio, then you are fully invested in equities. If you want income, then emerging market bonds should be seriously considered as a fully fledged asset class."
However, no bond is any better than its guarantor. The risk with high yielding bonds is that the price of a good income today could be capital erosion tomorrow.
Threadneedle's fund, which offers an average yield of 8.15 per cent to maturity, is one of two emerging market bond funds domiciled in the UK and authorised by the Financial Services Authority, and therefore covered by the official compensation scheme, which pays a maximum of £48,000 in the event of a default. The other is run by M&G.
There are more than a dozen other funds listed under the Standard & Poor's "fixed income global emerging markets" category that are based in Luxembourg and Ireland.
A spokesman for the FSA explains that some, but not all, of these funds are covered by the UK compensation rules because their parent management company is supervised directly by the UK watchdog.
He adds that all EU states must now by law have a compensation net for investors which covers 90 per cent of an investment up to a maximum of 20,000 - about £13,900, less than half the UK safety net. Some do pay more. He advises investors to check the standing of a particular fund before buying.
As a rule of thumb, most of the S&P listed emerging market fixed income and bond funds steer clear of corporate bonds - IOUs issued by local companies. "We don't do corporate," says Mr Murray-John. "You need a huge team on the ground and it can be very hard to do a proper investigation of the reports and accounts. You've also got the currency risk, which you don't have in the sovereign bond market because it is all traded in dollars."
Jerome Booth of Ashmore Investment Management, which specialises in emerging market debt, says: "There is massive prejudice among investors against emerging market bonds.
"You have got this big equity culture here in the UK and in the US and yet they ignore an asset class such as emerging market sovereign bonds which produce very attractive yields."
Investors with long memories may, however, recall the various Mexican financial crises of the 1970s and 1980s and the huge debt defaults in Latin America of the past decade - not to mention the crash that leapt from Brazil to Russia in 1998.
Mr Booth points out that today's politicians in charge of emerging market countries recognise that they must follow the rules on "openness and accountability" set down by the IMF and other bodies. "And," he adds, "you always need liquidity. Trading in global emerging market sovereign bonds is currently valued at around $3trillion. That's more than twice the value or liquidity of the FTSE 100 Index."
A lot of the new money that underpins emerging market bonds at present comes from big pension funds in the UK, US and Europe, according to Mr Booth. "It is very definitely an established trend now that pension funds have been forced to look for higher returns to cover widening deficits. Equities alone are simply not going to do that.
"Of course, there are risks," he adds. "But investing in property is a risk. So, too, is putting all your money into one asset class and one country, even if it is the UK. Look at it this way. You've got around 85 per cent of the world's population in emerging market countries. That's where the real economic growth and new markets will come from in the foreseeable future."
Keith Swabey, managing director of JP Morgan Fleming's fixed income division, says: "Everybody is risk-averse and I'm not suggesting that you come straight out of UK gilts and go for emerging market bonds. Take it a step at a time where, on the risk scale, gilts are one and emerging market sovereign bonds are five. But they have produced spectacular gains over the past few years compared with other asset classes and therefore deserve serious consideration."
What about future prospects? Mr Swabey says: "I think the biggest single risk comes from the dollar and the currency hit if US interest rates rise more quickly than anticipated. That would reduce the returns for UK investors. To put that in perspective, however, I'm talking about a total return of maybe 5 per cent or 6 per cent rather than the 6 per cent to 8 per cent you might expect if US rates rise more slowly, as predicted."
Martyn Ingram is a specialist fund analyst at Investors Partnership, which advises intermediaries such as independent financial advisers. For investors considering emerging market bond funds, he suggests: "Narrow the list down to those funds fully covered by the UK compensation scheme. As for your manager, you want someone who understands the politics and economics of emerging market countries. You want them to interpret the trends and to be there ahead of the crowd."
Mr Ingram's firm recommends Threadneedle's Emerging Markets Bond fund as well as the High Income rival run by Paul Thursby at Thames River. The fund analyst acknowledges that annual charges of around 1.5 per cent are steep but adds: "The right manager will make sure the performance of the underlying portfolio generates a total return that should more than outweigh the extra expense."
Rising interest rates are usually bad news for bondholders, because it makes the fixed interest or "coupon" they pay relatively less attractive.
But, despite last week's interest rate rise in China - the first in nine years - investors in emerging market bond funds have generally been rewarded for accepting high risks in recent years. The average return from this sector has been nearly double the average from all types of pooled fund over the past five years.
Although their outperformance has been more marginal over the past year, these funds have tended to benefit from investors' worst fears not being realised by subsequent events. Even so, this is not an investment sector for widows and orphans. Emerging market finance ministers at last month's annual meetings of the World Bank and International Monetary Fund (IMF) in Washington made outspoken verbal assaults on the greed of the world's richest nations, demonstrating that investors in their bonds need strong nerves.
In this instance, bonds are IOUs issued by the governments of developing countries. Taken at face value, many of the ministers' attacks appear to convey the threat of government debt defaults - refusal to pay interest or capital - as happened most recently in Argentina.
"There's always a bad news story somewhere," says Paul Murray-John, the manager of the £86m Threadneedle Emerging Market Bond fund, who attended the meetings. "But investors must look beyond what is in large part political posturing and point scoring for a domestic audience. If you study the investment fundamentals which underpin emerging market sovereign [government] bonds it is quite another story."
Mr Murray-John, whose investments include bonds issued by the governments of Brazil, Turkey, Bulgaria, Venezuela and Russia, adds: "These emerging market countries need the foreign money raised on the international bond markets to help their domestic economies grow. They talk tough but actually work very hard to make sure they meet the requirements on financial reporting, timely debt repayments and other governance issues laid down by authorities such as the IMF."
The Threadneedle manager, who has run the fund since its launch in 1997 with Russian-born Igor Ojereliev as his deputy, concedes that for many investors, and particularly risk-averse ones, putting money in emerging market bonds, even if they are issued by governments rather than companies, is a big step.
"But what is the alternative?" he asks. "In the past, UK gilts - bonds issued by the British Government - have yielded enough to meet the requirements of the most risk-averse investors. That is no longer the case. I would argue strongly that if you want to take risks with your portfolio, then you are fully invested in equities. If you want income, then emerging market bonds should be seriously considered as a fully fledged asset class."
However, no bond is any better than its guarantor. The risk with high yielding bonds is that the price of a good income today could be capital erosion tomorrow.
Threadneedle's fund, which offers an average yield of 8.15 per cent to maturity, is one of two emerging market bond funds domiciled in the UK and authorised by the Financial Services Authority, and therefore covered by the official compensation scheme, which pays a maximum of £48,000 in the event of a default. The other is run by M&G.
There are more than a dozen other funds listed under the Standard & Poor's "fixed income global emerging markets" category that are based in Luxembourg and Ireland.
A spokesman for the FSA explains that some, but not all, of these funds are covered by the UK compensation rules because their parent management company is supervised directly by the UK watchdog.
He adds that all EU states must now by law have a compensation net for investors which covers 90 per cent of an investment up to a maximum of 20,000 - about £13,900, less than half the UK safety net. Some do pay more. He advises investors to check the standing of a particular fund before buying.
As a rule of thumb, most of the S&P listed emerging market fixed income and bond funds steer clear of corporate bonds - IOUs issued by local companies. "We don't do corporate," says Mr Murray-John. "You need a huge team on the ground and it can be very hard to do a proper investigation of the reports and accounts. You've also got the currency risk, which you don't have in the sovereign bond market because it is all traded in dollars."
Jerome Booth of Ashmore Investment Management, which specialises in emerging market debt, says: "There is massive prejudice among investors against emerging market bonds.
"You have got this big equity culture here in the UK and in the US and yet they ignore an asset class such as emerging market sovereign bonds which produce very attractive yields."
Investors with long memories may, however, recall the various Mexican financial crises of the 1970s and 1980s and the huge debt defaults in Latin America of the past decade - not to mention the crash that leapt from Brazil to Russia in 1998.
Mr Booth points out that today's politicians in charge of emerging market countries recognise that they must follow the rules on "openness and accountability" set down by the IMF and other bodies. "And," he adds, "you always need liquidity. Trading in global emerging market sovereign bonds is currently valued at around $3trillion. That's more than twice the value or liquidity of the FTSE 100 Index."
A lot of the new money that underpins emerging market bonds at present comes from big pension funds in the UK, US and Europe, according to Mr Booth. "It is very definitely an established trend now that pension funds have been forced to look for higher returns to cover widening deficits. Equities alone are simply not going to do that.
"Of course, there are risks," he adds. "But investing in property is a risk. So, too, is putting all your money into one asset class and one country, even if it is the UK. Look at it this way. You've got around 85 per cent of the world's population in emerging market countries. That's where the real economic growth and new markets will come from in the foreseeable future."
Keith Swabey, managing director of JP Morgan Fleming's fixed income division, says: "Everybody is risk-averse and I'm not suggesting that you come straight out of UK gilts and go for emerging market bonds. Take it a step at a time where, on the risk scale, gilts are one and emerging market sovereign bonds are five. But they have produced spectacular gains over the past few years compared with other asset classes and therefore deserve serious consideration."
What about future prospects? Mr Swabey says: "I think the biggest single risk comes from the dollar and the currency hit if US interest rates rise more quickly than anticipated. That would reduce the returns for UK investors. To put that in perspective, however, I'm talking about a total return of maybe 5 per cent or 6 per cent rather than the 6 per cent to 8 per cent you might expect if US rates rise more slowly, as predicted."
Martyn Ingram is a specialist fund analyst at Investors Partnership, which advises intermediaries such as independent financial advisers. For investors considering emerging market bond funds, he suggests: "Narrow the list down to those funds fully covered by the UK compensation scheme. As for your manager, you want someone who understands the politics and economics of emerging market countries. You want them to interpret the trends and to be there ahead of the crowd."
Mr Ingram's firm recommends Threadneedle's Emerging Markets Bond fund as well as the High Income rival run by Paul Thursby at Thames River. The fund analyst acknowledges that annual charges of around 1.5 per cent are steep but adds: "The right manager will make sure the performance of the underlying portfolio generates a total return that should more than outweigh the extra expense."
Sunday, November 07, 2004
The Sunburn - Iran's Awesome Nuclear Anti-Ship Missile
The Sunburn
Iran's Awesome Nuclear Anti-Ship Missile
The Weapon That Could Defeat The US In The Gulf
By Mark Gaffney11-2-4
A word to the reader: The following paper is so shocking that, after preparing the initial draft, I didn't want to believe it myself, and resolved to disprove it with more research. However, I only succeeded in turning up more evidence in support of my thesis. And I repeated this cycle of discovery and denial several more times before finally deciding to go with the article. I believe that a serious writer must follow the trail of evidence, no matter where it leads, and report back. So here is my story. Don't be surprised if it causes you to squirm. Its purpose is not to make predictions history makes fools of those who claim to know the future but simply to describe the peril that awaits us in the Persian Gulf. By awakening to the extent of that danger, perhaps we can still find a way to save our nation and the world from disaster. If we are very lucky, we might even create an alternative future that holds some promise of resolving the monumental conflicts of our time. --MG
Last July, they dubbed it operation Summer Pulse: a simultaneous mustering of US Naval forces, world wide, that was unprecedented. According to the Navy, it was the first exercise of its new Fleet Response Plan (FRP), the purpose of which was to enable the Navy to respond quickly to an international crisis. The Navy wanted to show its increased force readiness, that is, its capacity to rapidly move combat power to any global hot spot. Never in the history of the US Navy had so many carrier battle groups been involved in a single operation. Even the US fleet massed in the Gulf and eastern Mediterranean during operation Desert Storm in 1991, and in the recent invasion of Iraq, never exceeded six battle groups. But last July and August there were seven of them on the move, each battle group consisting of a Nimitz-class aircraft carrier with its full complement of 7-8 supporting ships, and 70 or more assorted aircraft. Most of the activity, according to various reports, was in the Pacific, where the fleet participated in joint exercises with the Taiwanese navy.
But why so much naval power underway at the same time? What potential world crisis could possibly require more battle groups than were deployed during the recent invasion of Iraq? In past years, when the US has seen fit to "show the flag" or flex its naval muscle, one or two carrier groups have sufficed. Why this global show of power? The news headlines about the joint-maneuvers in the South China Sea read: "Saber Rattling Unnerves China", and: "Huge Show of Force Worries Chinese." But the reality was quite different, and, as we shall see, has grave ramifications for the continuing US military presence in the Persian Gulf; because operation Summer Pulse reflected a high-level Pentagon decision that an unprecedented show of strength was needed to counter what is viewed as a growing threat in the particular case of China, because of Peking's newest Sovremenny-class destroyers recently acquired from Russia.
"Nonsense!" you are probably thinking. That's impossible. How could a few picayune destroyers threaten the US Pacific fleet?" Here is where the story thickens: Summer Pulse amounted to a tacit acknowledgement, obvious to anyone paying attention, that the United States has been eclipsed in an important area of military technology, and that this qualitative edge is now being wielded by others, including the Chinese; because those otherwise very ordinary destroyers were, in fact, launching platforms for Russian-made 3M-82 Moskit anti-ship cruise missiles (NATO designation: SS-N-22 Sunburn), a weapon for which the US Navy currently has no defense. Here I am not suggesting that the US status of lone world Superpower has been surpassed. I am simply saying that a new global balance of power is emerging, in which other individual states may, on occasion, achieve "an asymmetric advantage" over the US. And this, in my view, explains the immense scale of Summer Pulse. The US show last summer of overwhelming strength was calculated to send a message.
The Sunburn Missile
I was shocked when I learned the facts about these Russian-made cruise missiles. The problem is that so many of us suffer from two common misperceptions. The first follows from our assumption that Russia is militarily weak, as a result of the breakup of the old Soviet system. Actually, this is accurate, but it does not reflect the complexities. Although the Russian navy continues to rust in port, and the Russian army is in disarray, in certain key areas Russian technology is actually superior to our own. And nowhere is this truer than in the vital area of anti-ship cruise missile technology, where the Russians hold at least a ten-year lead over the US. The second misperception has to do with our complacency in general about missiles-as-weapons probably attributable to the pathetic performance of Saddam Hussein's Scuds during the first Gulf war: a dangerous illusion that I will now attempt to rectify.
Many years ago, Soviet planners gave up trying to match the US Navy ship for ship, gun for gun, and dollar for dollar. The Soviets simply could not compete with the high levels of US spending required to build up and maintain a huge naval armada. They shrewdly adopted an alternative approach based on strategic defense. They searched for weaknesses, and sought relatively inexpensive ways to exploit those weaknesses. The Soviets succeeded: by developing several supersonic anti-ship missiles, one of which, the SS-N-22 Sunburn, has been called "the most lethal missile in the world today."
After the collapse of the Soviet Union the old military establishment fell upon hard times. But in the late1990s Moscow awakened to the under-utilized potential of its missile technology to generate desperately needed foreign exchange. A decision was made to resuscitate selected programs, and, very soon, Russian missile technology became a hot export commodity. Today, Russian missiles are a growth industry generating much-needed cash for Russia, with many billions in combined sales to India, China, Viet Nam, Cuba, and also Iran. In the near future this dissemination of advanced technology is likely to present serious challenges to the US. Some have even warned that the US Navy's largest ships, the massive carriers, have now become floating death traps, and should for this reason be mothballed.
The Sunburn missile has never seen use in combat, to my knowledge, which probably explains why its fearsome capabilities are not more widely recognized. Other cruise missiles have been used, of course, on several occasions, and with devastating results. During the Falklands War, French-made Exocet missiles, fired from Argentine fighters, sunk the HMS Sheffield and another ship. And, in 1987, during the Iran-Iraq war, the USS Stark was nearly cut in half by a pair of Exocets while on patrol in the Persian Gulf. On that occasion US Aegis radar picked up the incoming Iraqi fighter (a French-made Mirage), and tracked its approach to within 50 miles. The radar also "saw" the Iraqi plane turn about and return to its base. But radar never detected the pilot launch his weapons. The sea-skimming Exocets came smoking in under radar and were only sighted by human eyes moments before they ripped into the Stark, crippling the ship and killing 37 US sailors.
The 1987 surprise attack on the Stark exemplifies the dangers posed by anti-ship cruise missiles. And the dangers are much more serious in the case of the Sunburn, whose specs leave the sub-sonic Exocet in the dust. Not only is the Sunburn much larger and faster, it has far greater range and a superior guidance system. Those who have witnessed its performance trials invariably come away stunned. According to one report, when the Iranian Defense Minister Ali Shamkhani visited Moscow in October 2001 he requested a test firing of the Sunburn, which the Russians were only too happy to arrange. So impressed was Ali Shamkhani that he placed an order for an undisclosed number of the missiles.
The Sunburn can deliver a 200-kiloton nuclear payload, or: a 750-pound conventional warhead, within a range of 100 miles, more than twice the range of the Exocet. The Sunburn combines a Mach 2.1 speed (two times the speed of sound) with a flight pattern that hugs the deck and includes "violent end maneuvers" to elude enemy defenses. The missile was specifically designed to defeat the US Aegis radar defense system. Should a US Navy Phalanx point defense somehow manage to detect an incoming Sunburn missile, the system has only seconds to calculate a fire solution not enough time to take out the intruding missile. The US Phalanx defense employs a six-barreled gun that fires 3,000 depleted-uranium rounds a minute, but the gun must have precise coordinates to destroy an intruder "just in time."
The Sunburn's combined supersonic speed and payload size produce tremendous kinetic energy on impact, with devastating consequences for ship and crew. A single one of these missiles can sink a large warship, yet costs considerably less than a fighter jet. Although the Navy has been phasing out the older Phalanx defense system, its replacement, known as the Rolling Action Missile (RAM) has never been tested against the weapon it seems destined to one day face in combat. Implications For US Forces in the Gulf
The US Navy's only plausible defense against a robust weapon like the Sunburn missile is to detect the enemy's approach well ahead of time, whether destroyers, subs, or fighter-bombers, and defeat them before they can get in range and launch their deadly cargo. For this purpose US AWACs radar planes assigned to each naval battle group are kept aloft on a rotating schedule. The planes "see" everything within two hundred miles of the fleet, and are complemented with intelligence from orbiting satellites.
But US naval commanders operating in the Persian Gulf face serious challenges that are unique to the littoral, i.e., coastal, environment. A glance at a map shows why: The Gulf is nothing but a large lake, with one narrow outlet, and most of its northern shore, i.e., Iran, consists of mountainous terrain that affords a commanding tactical advantage over ships operating in Gulf waters. The rugged northern shore makes for easy concealment of coastal defenses, such as mobile missile launchers, and also makes their detection problematic. Although it was not widely reported, the US actually lost the battle of the Scuds in the first Gulf War termed "the great Scud hunt" and for similar reasons.
Saddam Hussein's mobile Scud launchers proved so difficult to detect and destroy over and over again the Iraqis fooled allied reconnaissance with decoys that during the course of Desert Storm the US was unable to confirm even a single kill. This proved such an embarrassment to the Pentagon, afterwards, that the unpleasant stats were buried in official reports. But the blunt fact is that the US failed to stop the Scud attacks. The launches continued until the last few days of the conflict. Luckily, the Scud's inaccuracy made it an almost useless weapon. At one point General Norman Schwarzkopf quipped dismissively to the press that his soldiers had a greater chance of being struck by lightning in Georgia than by a Scud in Kuwait.
But that was then, and it would be a grave error to allow the Scud's ineffectiveness to blur the facts concerning this other missile. The Sunburn's amazing accuracy was demonstrated not long ago in a live test staged at sea by the Chinese and observed by US spy planes. Not only did the Sunburn missile destroy the dummy target ship, it scored a perfect bull's eye, hitting the crosshairs of a large "X" mounted on the ship's bridge. The only word that does it justice, awesome, has become a cliché, hackneyed from hyperbolic excess.
The US Navy has never faced anything in combat as formidable as the Sunburn missile. But this will surely change if the US and Israel decide to wage a so-called preventive war against Iran to destroy its nuclear infrastructure. Storm clouds have been darkening over the Gulf for many months. In recent years Israel upgraded its air force with a new fleet of long-range F-15 fighter-bombers, and even more recently took delivery of 5,000 bunker-buster bombs from the US weapons that many observers think are intended for use against Iran.
The arming for war has been matched by threats. Israeli officials have declared repeatedly that they will not allow the Mullahs to develop nuclear power, not even reactors to generate electricity for peaceful use. Their threats are particularly worrisome, because Israel has a long history of pre-emptive war. (See my 1989 book Dimona: the Third Temple? and also my 2003 article Will Iran Be Next? posted at http://www.InformationClearingHouse.info/article3288.htm )
Never mind that such a determination is not Israel's to make, and belongs instead to the international community, as codified in the Nonproliferation Treaty (NPT). With regard to Iran, the International Atomic Energy Agency's (IAEA's) recent report (September 2004) is well worth a look, as it repudiates facile claims by the US and Israel that Iran is building bombs. While the report is highly critical of Tehran for its ambiguities and its grudging release of documents, it affirms that IAEA inspectors have been admitted to every nuclear site in the country to which they have sought access, without exception. Last year Iran signed the strengthened IAEA inspection protocol, which until then had been voluntary. And the IAEA has found no hard evidence, to date, either that bombs exist or that Iran has made a decision to build them.
(The latest IAEA report can be downloaded at: http://www.GlobalSecurity.org)
In a talk on October 3, 2004, IAEA Director General Mohamed El Baradei made the clearest statement yet: "Iran has no nuclear weapons program", he said, and then repeated himself for emphasis: "Iran has no nuclear weapons program, but I personally don't rush to conclusions before all the realities are clarified. So far I see nothing that could be called an imminent danger. I have seen no nuclear weapons program in Iran. What I have seen is that Iran is trying to gain access to nuclear enrichment technology, and so far there is no danger from Iran. Therefore, we should make use of political and diplomatic means before thinking of resorting to other alternatives."
No one disputes that Tehran is pursuing a dangerous path, but with 200 or more Israeli nukes targeted upon them the Iranians' insistence on keeping their options open is understandable. Clearly, the nuclear nonproliferation regime today hangs by the slenderest of threads. The world has arrived at a fateful crossroads.
A Fearful Symmetry?
If a showdown over Iran develops in the coming months, the man who could hold the outcome in his hands will be thrust upon the world stage. That man, like him or hate him, is Russian President Vladimir Putin. He has been castigated severely in recent months for gathering too much political power to himself. But according to former Soviet President Mikhail Gorbachev, who was interviewed on US television recently by David Brokaw, Putin has not imposed a tyranny upon Russia yet. Gorbachev thinks the jury is still out on Putin.
Perhaps, with this in mind, we should be asking whether Vladimir Putin is a serious student of history. If he is, then he surely recognizes that the deepening crisis in the Persian Gulf presents not only manifold dangers, but also opportunities. Be assured that the Russian leader has not forgotten the humiliating defeat Ronald Reagan inflicted upon the old Soviet state. (Have we Americans forgotten?) By the mid-1980s the Soviets were in Kabul, and had all but defeated the Mujahedeen. The Soviet Union appeared secure in its military occupation of Afghanistan. But then, in 1986, the first US Stinger missiles reached the hands of the Afghani resistance; and, quite suddenly, Soviet helicopter gunships and MiGs began dropping out of the skies like flaming stones. The tide swiftly turned, and by 1989 it was all over but the hand wringing and gnashing of teeth in the Kremlin. Defeated, the Soviets slunk back across the frontier. The whole world cheered the American Stingers, which had carried the day.
This very night, as he sips his cognac, what is Vladimir Putin thinking? Is he perhaps thinking about the perverse symmetries of history? If so, he may also be wondering (and discussing with his closest aides) how a truly great nation like the United States could be so blind and so stupid as to allow another state, i.e., Israel, to control its foreign policy, especially in a region as vital (and volatile) as the Mid-East.
One can almost hear the Russians' animated conversation:
"The Americans! What is the matter with them?" "They simply cannot help themselves."
"What idiots!"
"A nation as foolish as this deserves to be taught a lesson"
"Yes! For their own good."
"It must be a painful lesson, one they will never forget. "Are we agreed, then, comrades?"
"Let us teach our American friends a lesson about the limits of military power..."
Does anyone really believe that Vladimir Putin will hesitate to seize a most rare opportunity to change the course of history and, in the bargain, take his sweet revenge? Surely Putin understands the terrible dimensions of the trap into which the US has blundered, thanks to the Israelis and their neo-con supporters in Washington who lobbied so vociferously for the 2003 invasion of Iraq, against all friendly and expert advice, and who even now beat the drums of war against Iran. Would Putin be wrong to conclude that the US will never leave the region unless it is first defeated militarily? Should we blame him for deciding that Iran is "one bridge too far"?
If the US and Israel overreach, and the Iranians close the net with Russian anti-ship missiles, it will be a fearful symmetry, indeed.
Springing the Trap
At the battle of Cannae in 216 BC, the great Carthaginian general, Hannibal, tempted a much larger Roman army into a fateful advance, and then enveloped and annihilated it with a smaller force. Out of a Roman army of 70,000 men, no more than a few thousand escaped. It was said that after many hours of dispatching the Romans, Hannibal's soldiers grew so tired that the fight went out of them. In their weariness they granted the last broken and bedraggled Romans their lives.
Let us pray that the US sailors who are unlucky enough to be on duty in the Persian Gulf when the shooting starts can escape the fate of the Roman army at Cannae. The odds will be heavily against them, however, because they will face the same type of danger, tantamount to envelopment. The US ships in the Gulf will already have come within range of the Sunburn missiles and the even more-advanced SS-NX-26 Yakhonts missiles, also Russian-made (speed: Mach 2.9; range: 180 miles) deployed by the Iranians along the Gulf's northern shore. Every US ship will be exposed and vulnerable. When the Iranians spring the trap, the entire lake will become a killing field.
Anti-ship cruise missiles are not new, as I've mentioned. Nor have they yet determined the outcome in a conflict. But this is probably only because these horrible weapons have never been deployed in sufficient numbers. At the time of the Falklands war the Argentine air force possessed only five Exocets, yet managed to sink two ships. With enough of them, the Argentineans might have sunk the entire British fleet, and won the war. Although we've never seen a massed attack of cruise missiles, this is exactly what the US Navy could face in the next war in the Gulf.
Try and imagine it if you can: barrage after barrage of Exocet-class missiles, which the Iranians are known to possess in the hundreds, as well as the unstoppable Sunburn and Yakhonts missiles. The questions that our purblind government leaders should be asking themselves, today, if they value what historians will one day write about them, are two: how many of the Russian anti-ship missiles has Putin already supplied to Iran? And: How many more are currently in the pipeline?
In 2001, Jane's Defense Weekly reported that Iran was attempting to acquire anti-ship missiles from Russia. Ominously, the same report also mentioned that the more advanced Yakhonts missile was "optimized for attacks against carrier task forces." Apparently its guidance system is "able to distinguish an aircraft carrier from its escorts." The numbers were not disclosed.
The US Navy will come under fire even if the US does not participate in the first so-called surgical raids on Iran's nuclear sites, that is, even if Israel goes it alone. Israel's brand-new fleet of 25 F-15s (paid for by American taxpayers) has sufficient range to target Iran, but the Israelis cannot mount an attack without crossing US-occupied Iraqi air space. It will hardly matter if Washington gives the green light, or is dragged into the conflict by a recalcitrant Israel. Either way, the result will be the same. The Iranians will interpret US acquiescence as complicity, and, in any event, they will understand that the real fight is with the Americans. The Iranians will be entirely within their rights to counter-attack in self-defense. Most of the world will see it this way, and will support them, not America. The US and Israel will be viewed as the aggressors, even as the unfortunate US sailors in harm's way become cannon fodder. In the Gulf's shallow and confined waters evasive maneuvers will be difficult, at best, and escape impossible. Even if US planes control of the skies over the battlefield, the sailors caught in the net below will be hard-pressed to survive. The Gulf will run red with American blood.
From here, it only gets worse. Armed with their Russian-supplied cruise missiles, the Iranians will close the lake's only outlet, the strategic Strait of Hormuz, cutting off the trapped and dying Americans from help and rescue. The US fleet massing in the Indian Ocean will stand by helplessly, unable to enter the Gulf to assist the survivors or bring logistical support to the other US forces on duty in Iraq. Couple this with a major new ground offensive by the Iraqi insurgents, and, quite suddenly, the tables could turn against the Americans in Baghdad. As supplies and ammunition begin to run out, the status of US forces in the region will become precarious. The occupiers will become the besieged.
With enough anti-ship missiles, the Iranians can halt tanker traffic through Hormuz for weeks, even months. With the flow of oil from the Gulf curtailed, the price of a barrel of crude will skyrocket on the world market. Within days the global economy will begin to grind to a halt. Tempers at an emergency round-the-clock session of the UN Security Council will flare and likely explode into shouting and recriminations as French, German, Chinese and even British ambassadors angrily accuse the US of allowing Israel to threaten world order. But, as always, because of the US veto the world body will be powerless to act... America will stand alone, completely isolated.
Yet, despite the increasingly hostile international mood, elements of the US media will spin the crisis very differently here at home, in a way that is sympathetic to Israel. Members of Congress will rise to speak in the House and Senate, and rally to Israel's defense, while blaming the victim of the attack, Iran. Fundamentalist Christian talk show hosts will proclaim the historic fulfillment of biblical prophecy in our time, and will call upon the Jews of Israel to accept Jesus into their hearts; meanwhile, urging the president to nuke the evil empire of Islam. From across America will be heard histrionic cries for fresh reinforcements, even a military draft. Patriots will demand victory at any cost. Pundits will scream for an escalation of the conflict.
A war that ostensibly began as an attempt to prevent the spread of nuclear weapons will teeter on the brink of their use.
Conclusion
Friends, we must work together to prevent such a catastrophe. We must stop the next Middle East war before it starts. The US government must turn over to the United Nations the primary responsibility for resolving the deepening crisis in Iraq, and, immediately thereafter, withdraw US forces from the country. We must also prevail upon the Israelis to sign the Nonproliferation Treaty (NPT) and open all of their nuclear sites to IAEA inspectors. Only then can serious talks begin with Iran and other states to establish a nuclear weapon free zone (NWFZ) in the Mid East so essential to the region's long-term peace and security. 10/26/04 "ICH"
Last July, they dubbed it operation Summer Pulse: a simultaneous mustering of US Naval forces, world wide, that was unprecedented. According to the Navy, it was the first exercise of its new Fleet Response Plan (FRP), the purpose of which was to enable the Navy to respond quickly to an international crisis. The Navy wanted to show its increased force readiness, that is, its capacity to rapidly move combat power to any global hot spot. Never in the history of the US Navy had so many carrier battle groups been involved in a single operation. Even the US fleet massed in the Gulf and eastern Mediterranean during operation Desert Storm in 1991, and in the recent invasion of Iraq, never exceeded six battle groups. But last July and August there were seven of them on the move, each battle group consisting of a Nimitz-class aircraft carrier with its full complement of 7-8 supporting ships, and 70 or more assorted aircraft. Most of the activity, according to various reports, was in the Pacific, where the fleet participated in joint exercises with the Taiwanese navy.
But why so much naval power underway at the same time? What potential world crisis could possibly require more battle groups than were deployed during the recent invasion of Iraq? In past years, when the US has seen fit to "show the flag" or flex its naval muscle, one or two carrier groups have sufficed. Why this global show of power? The news headlines about the joint-maneuvers in the South China Sea read: "Saber Rattling Unnerves China", and: "Huge Show of Force Worries Chinese." But the reality was quite different, and, as we shall see, has grave ramifications for the continuing US military presence in the Persian Gulf; because operation Summer Pulse reflected a high-level Pentagon decision that an unprecedented show of strength was needed to counter what is viewed as a growing threat in the particular case of China, because of Peking's newest Sovremenny-class destroyers recently acquired from Russia.
"Nonsense!" you are probably thinking. That's impossible. How could a few picayune destroyers threaten the US Pacific fleet?" Here is where the story thickens: Summer Pulse amounted to a tacit acknowledgement, obvious to anyone paying attention, that the United States has been eclipsed in an important area of military technology, and that this qualitative edge is now being wielded by others, including the Chinese; because those otherwise very ordinary destroyers were, in fact, launching platforms for Russian-made 3M-82 Moskit anti-ship cruise missiles (NATO designation: SS-N-22 Sunburn), a weapon for which the US Navy currently has no defense. Here I am not suggesting that the US status of lone world Superpower has been surpassed. I am simply saying that a new global balance of power is emerging, in which other individual states may, on occasion, achieve "an asymmetric advantage" over the US. And this, in my view, explains the immense scale of Summer Pulse. The US show last summer of overwhelming strength was calculated to send a message.
The Sunburn Missile
I was shocked when I learned the facts about these Russian-made cruise missiles. The problem is that so many of us suffer from two common misperceptions. The first follows from our assumption that Russia is militarily weak, as a result of the breakup of the old Soviet system. Actually, this is accurate, but it does not reflect the complexities. Although the Russian navy continues to rust in port, and the Russian army is in disarray, in certain key areas Russian technology is actually superior to our own. And nowhere is this truer than in the vital area of anti-ship cruise missile technology, where the Russians hold at least a ten-year lead over the US. The second misperception has to do with our complacency in general about missiles-as-weapons probably attributable to the pathetic performance of Saddam Hussein's Scuds during the first Gulf war: a dangerous illusion that I will now attempt to rectify.
Many years ago, Soviet planners gave up trying to match the US Navy ship for ship, gun for gun, and dollar for dollar. The Soviets simply could not compete with the high levels of US spending required to build up and maintain a huge naval armada. They shrewdly adopted an alternative approach based on strategic defense. They searched for weaknesses, and sought relatively inexpensive ways to exploit those weaknesses. The Soviets succeeded: by developing several supersonic anti-ship missiles, one of which, the SS-N-22 Sunburn, has been called "the most lethal missile in the world today."
After the collapse of the Soviet Union the old military establishment fell upon hard times. But in the late1990s Moscow awakened to the under-utilized potential of its missile technology to generate desperately needed foreign exchange. A decision was made to resuscitate selected programs, and, very soon, Russian missile technology became a hot export commodity. Today, Russian missiles are a growth industry generating much-needed cash for Russia, with many billions in combined sales to India, China, Viet Nam, Cuba, and also Iran. In the near future this dissemination of advanced technology is likely to present serious challenges to the US. Some have even warned that the US Navy's largest ships, the massive carriers, have now become floating death traps, and should for this reason be mothballed.
The Sunburn missile has never seen use in combat, to my knowledge, which probably explains why its fearsome capabilities are not more widely recognized. Other cruise missiles have been used, of course, on several occasions, and with devastating results. During the Falklands War, French-made Exocet missiles, fired from Argentine fighters, sunk the HMS Sheffield and another ship. And, in 1987, during the Iran-Iraq war, the USS Stark was nearly cut in half by a pair of Exocets while on patrol in the Persian Gulf. On that occasion US Aegis radar picked up the incoming Iraqi fighter (a French-made Mirage), and tracked its approach to within 50 miles. The radar also "saw" the Iraqi plane turn about and return to its base. But radar never detected the pilot launch his weapons. The sea-skimming Exocets came smoking in under radar and were only sighted by human eyes moments before they ripped into the Stark, crippling the ship and killing 37 US sailors.
The 1987 surprise attack on the Stark exemplifies the dangers posed by anti-ship cruise missiles. And the dangers are much more serious in the case of the Sunburn, whose specs leave the sub-sonic Exocet in the dust. Not only is the Sunburn much larger and faster, it has far greater range and a superior guidance system. Those who have witnessed its performance trials invariably come away stunned. According to one report, when the Iranian Defense Minister Ali Shamkhani visited Moscow in October 2001 he requested a test firing of the Sunburn, which the Russians were only too happy to arrange. So impressed was Ali Shamkhani that he placed an order for an undisclosed number of the missiles.
The Sunburn can deliver a 200-kiloton nuclear payload, or: a 750-pound conventional warhead, within a range of 100 miles, more than twice the range of the Exocet. The Sunburn combines a Mach 2.1 speed (two times the speed of sound) with a flight pattern that hugs the deck and includes "violent end maneuvers" to elude enemy defenses. The missile was specifically designed to defeat the US Aegis radar defense system. Should a US Navy Phalanx point defense somehow manage to detect an incoming Sunburn missile, the system has only seconds to calculate a fire solution not enough time to take out the intruding missile. The US Phalanx defense employs a six-barreled gun that fires 3,000 depleted-uranium rounds a minute, but the gun must have precise coordinates to destroy an intruder "just in time."
The Sunburn's combined supersonic speed and payload size produce tremendous kinetic energy on impact, with devastating consequences for ship and crew. A single one of these missiles can sink a large warship, yet costs considerably less than a fighter jet. Although the Navy has been phasing out the older Phalanx defense system, its replacement, known as the Rolling Action Missile (RAM) has never been tested against the weapon it seems destined to one day face in combat. Implications For US Forces in the Gulf
The US Navy's only plausible defense against a robust weapon like the Sunburn missile is to detect the enemy's approach well ahead of time, whether destroyers, subs, or fighter-bombers, and defeat them before they can get in range and launch their deadly cargo. For this purpose US AWACs radar planes assigned to each naval battle group are kept aloft on a rotating schedule. The planes "see" everything within two hundred miles of the fleet, and are complemented with intelligence from orbiting satellites.
But US naval commanders operating in the Persian Gulf face serious challenges that are unique to the littoral, i.e., coastal, environment. A glance at a map shows why: The Gulf is nothing but a large lake, with one narrow outlet, and most of its northern shore, i.e., Iran, consists of mountainous terrain that affords a commanding tactical advantage over ships operating in Gulf waters. The rugged northern shore makes for easy concealment of coastal defenses, such as mobile missile launchers, and also makes their detection problematic. Although it was not widely reported, the US actually lost the battle of the Scuds in the first Gulf War termed "the great Scud hunt" and for similar reasons.
Saddam Hussein's mobile Scud launchers proved so difficult to detect and destroy over and over again the Iraqis fooled allied reconnaissance with decoys that during the course of Desert Storm the US was unable to confirm even a single kill. This proved such an embarrassment to the Pentagon, afterwards, that the unpleasant stats were buried in official reports. But the blunt fact is that the US failed to stop the Scud attacks. The launches continued until the last few days of the conflict. Luckily, the Scud's inaccuracy made it an almost useless weapon. At one point General Norman Schwarzkopf quipped dismissively to the press that his soldiers had a greater chance of being struck by lightning in Georgia than by a Scud in Kuwait.
But that was then, and it would be a grave error to allow the Scud's ineffectiveness to blur the facts concerning this other missile. The Sunburn's amazing accuracy was demonstrated not long ago in a live test staged at sea by the Chinese and observed by US spy planes. Not only did the Sunburn missile destroy the dummy target ship, it scored a perfect bull's eye, hitting the crosshairs of a large "X" mounted on the ship's bridge. The only word that does it justice, awesome, has become a cliché, hackneyed from hyperbolic excess.
The US Navy has never faced anything in combat as formidable as the Sunburn missile. But this will surely change if the US and Israel decide to wage a so-called preventive war against Iran to destroy its nuclear infrastructure. Storm clouds have been darkening over the Gulf for many months. In recent years Israel upgraded its air force with a new fleet of long-range F-15 fighter-bombers, and even more recently took delivery of 5,000 bunker-buster bombs from the US weapons that many observers think are intended for use against Iran.
The arming for war has been matched by threats. Israeli officials have declared repeatedly that they will not allow the Mullahs to develop nuclear power, not even reactors to generate electricity for peaceful use. Their threats are particularly worrisome, because Israel has a long history of pre-emptive war. (See my 1989 book Dimona: the Third Temple? and also my 2003 article Will Iran Be Next? posted at http://www.InformationClearingHouse.info/article3288.htm )
Never mind that such a determination is not Israel's to make, and belongs instead to the international community, as codified in the Nonproliferation Treaty (NPT). With regard to Iran, the International Atomic Energy Agency's (IAEA's) recent report (September 2004) is well worth a look, as it repudiates facile claims by the US and Israel that Iran is building bombs. While the report is highly critical of Tehran for its ambiguities and its grudging release of documents, it affirms that IAEA inspectors have been admitted to every nuclear site in the country to which they have sought access, without exception. Last year Iran signed the strengthened IAEA inspection protocol, which until then had been voluntary. And the IAEA has found no hard evidence, to date, either that bombs exist or that Iran has made a decision to build them.
(The latest IAEA report can be downloaded at: http://www.GlobalSecurity.org)
In a talk on October 3, 2004, IAEA Director General Mohamed El Baradei made the clearest statement yet: "Iran has no nuclear weapons program", he said, and then repeated himself for emphasis: "Iran has no nuclear weapons program, but I personally don't rush to conclusions before all the realities are clarified. So far I see nothing that could be called an imminent danger. I have seen no nuclear weapons program in Iran. What I have seen is that Iran is trying to gain access to nuclear enrichment technology, and so far there is no danger from Iran. Therefore, we should make use of political and diplomatic means before thinking of resorting to other alternatives."
No one disputes that Tehran is pursuing a dangerous path, but with 200 or more Israeli nukes targeted upon them the Iranians' insistence on keeping their options open is understandable. Clearly, the nuclear nonproliferation regime today hangs by the slenderest of threads. The world has arrived at a fateful crossroads.
A Fearful Symmetry?
If a showdown over Iran develops in the coming months, the man who could hold the outcome in his hands will be thrust upon the world stage. That man, like him or hate him, is Russian President Vladimir Putin. He has been castigated severely in recent months for gathering too much political power to himself. But according to former Soviet President Mikhail Gorbachev, who was interviewed on US television recently by David Brokaw, Putin has not imposed a tyranny upon Russia yet. Gorbachev thinks the jury is still out on Putin.
Perhaps, with this in mind, we should be asking whether Vladimir Putin is a serious student of history. If he is, then he surely recognizes that the deepening crisis in the Persian Gulf presents not only manifold dangers, but also opportunities. Be assured that the Russian leader has not forgotten the humiliating defeat Ronald Reagan inflicted upon the old Soviet state. (Have we Americans forgotten?) By the mid-1980s the Soviets were in Kabul, and had all but defeated the Mujahedeen. The Soviet Union appeared secure in its military occupation of Afghanistan. But then, in 1986, the first US Stinger missiles reached the hands of the Afghani resistance; and, quite suddenly, Soviet helicopter gunships and MiGs began dropping out of the skies like flaming stones. The tide swiftly turned, and by 1989 it was all over but the hand wringing and gnashing of teeth in the Kremlin. Defeated, the Soviets slunk back across the frontier. The whole world cheered the American Stingers, which had carried the day.
This very night, as he sips his cognac, what is Vladimir Putin thinking? Is he perhaps thinking about the perverse symmetries of history? If so, he may also be wondering (and discussing with his closest aides) how a truly great nation like the United States could be so blind and so stupid as to allow another state, i.e., Israel, to control its foreign policy, especially in a region as vital (and volatile) as the Mid-East.
One can almost hear the Russians' animated conversation:
"The Americans! What is the matter with them?" "They simply cannot help themselves."
"What idiots!"
"A nation as foolish as this deserves to be taught a lesson"
"Yes! For their own good."
"It must be a painful lesson, one they will never forget. "Are we agreed, then, comrades?"
"Let us teach our American friends a lesson about the limits of military power..."
Does anyone really believe that Vladimir Putin will hesitate to seize a most rare opportunity to change the course of history and, in the bargain, take his sweet revenge? Surely Putin understands the terrible dimensions of the trap into which the US has blundered, thanks to the Israelis and their neo-con supporters in Washington who lobbied so vociferously for the 2003 invasion of Iraq, against all friendly and expert advice, and who even now beat the drums of war against Iran. Would Putin be wrong to conclude that the US will never leave the region unless it is first defeated militarily? Should we blame him for deciding that Iran is "one bridge too far"?
If the US and Israel overreach, and the Iranians close the net with Russian anti-ship missiles, it will be a fearful symmetry, indeed.
Springing the Trap
At the battle of Cannae in 216 BC, the great Carthaginian general, Hannibal, tempted a much larger Roman army into a fateful advance, and then enveloped and annihilated it with a smaller force. Out of a Roman army of 70,000 men, no more than a few thousand escaped. It was said that after many hours of dispatching the Romans, Hannibal's soldiers grew so tired that the fight went out of them. In their weariness they granted the last broken and bedraggled Romans their lives.
Let us pray that the US sailors who are unlucky enough to be on duty in the Persian Gulf when the shooting starts can escape the fate of the Roman army at Cannae. The odds will be heavily against them, however, because they will face the same type of danger, tantamount to envelopment. The US ships in the Gulf will already have come within range of the Sunburn missiles and the even more-advanced SS-NX-26 Yakhonts missiles, also Russian-made (speed: Mach 2.9; range: 180 miles) deployed by the Iranians along the Gulf's northern shore. Every US ship will be exposed and vulnerable. When the Iranians spring the trap, the entire lake will become a killing field.
Anti-ship cruise missiles are not new, as I've mentioned. Nor have they yet determined the outcome in a conflict. But this is probably only because these horrible weapons have never been deployed in sufficient numbers. At the time of the Falklands war the Argentine air force possessed only five Exocets, yet managed to sink two ships. With enough of them, the Argentineans might have sunk the entire British fleet, and won the war. Although we've never seen a massed attack of cruise missiles, this is exactly what the US Navy could face in the next war in the Gulf.
Try and imagine it if you can: barrage after barrage of Exocet-class missiles, which the Iranians are known to possess in the hundreds, as well as the unstoppable Sunburn and Yakhonts missiles. The questions that our purblind government leaders should be asking themselves, today, if they value what historians will one day write about them, are two: how many of the Russian anti-ship missiles has Putin already supplied to Iran? And: How many more are currently in the pipeline?
In 2001, Jane's Defense Weekly reported that Iran was attempting to acquire anti-ship missiles from Russia. Ominously, the same report also mentioned that the more advanced Yakhonts missile was "optimized for attacks against carrier task forces." Apparently its guidance system is "able to distinguish an aircraft carrier from its escorts." The numbers were not disclosed.
The US Navy will come under fire even if the US does not participate in the first so-called surgical raids on Iran's nuclear sites, that is, even if Israel goes it alone. Israel's brand-new fleet of 25 F-15s (paid for by American taxpayers) has sufficient range to target Iran, but the Israelis cannot mount an attack without crossing US-occupied Iraqi air space. It will hardly matter if Washington gives the green light, or is dragged into the conflict by a recalcitrant Israel. Either way, the result will be the same. The Iranians will interpret US acquiescence as complicity, and, in any event, they will understand that the real fight is with the Americans. The Iranians will be entirely within their rights to counter-attack in self-defense. Most of the world will see it this way, and will support them, not America. The US and Israel will be viewed as the aggressors, even as the unfortunate US sailors in harm's way become cannon fodder. In the Gulf's shallow and confined waters evasive maneuvers will be difficult, at best, and escape impossible. Even if US planes control of the skies over the battlefield, the sailors caught in the net below will be hard-pressed to survive. The Gulf will run red with American blood.
From here, it only gets worse. Armed with their Russian-supplied cruise missiles, the Iranians will close the lake's only outlet, the strategic Strait of Hormuz, cutting off the trapped and dying Americans from help and rescue. The US fleet massing in the Indian Ocean will stand by helplessly, unable to enter the Gulf to assist the survivors or bring logistical support to the other US forces on duty in Iraq. Couple this with a major new ground offensive by the Iraqi insurgents, and, quite suddenly, the tables could turn against the Americans in Baghdad. As supplies and ammunition begin to run out, the status of US forces in the region will become precarious. The occupiers will become the besieged.
With enough anti-ship missiles, the Iranians can halt tanker traffic through Hormuz for weeks, even months. With the flow of oil from the Gulf curtailed, the price of a barrel of crude will skyrocket on the world market. Within days the global economy will begin to grind to a halt. Tempers at an emergency round-the-clock session of the UN Security Council will flare and likely explode into shouting and recriminations as French, German, Chinese and even British ambassadors angrily accuse the US of allowing Israel to threaten world order. But, as always, because of the US veto the world body will be powerless to act... America will stand alone, completely isolated.
Yet, despite the increasingly hostile international mood, elements of the US media will spin the crisis very differently here at home, in a way that is sympathetic to Israel. Members of Congress will rise to speak in the House and Senate, and rally to Israel's defense, while blaming the victim of the attack, Iran. Fundamentalist Christian talk show hosts will proclaim the historic fulfillment of biblical prophecy in our time, and will call upon the Jews of Israel to accept Jesus into their hearts; meanwhile, urging the president to nuke the evil empire of Islam. From across America will be heard histrionic cries for fresh reinforcements, even a military draft. Patriots will demand victory at any cost. Pundits will scream for an escalation of the conflict.
A war that ostensibly began as an attempt to prevent the spread of nuclear weapons will teeter on the brink of their use.
Conclusion
Friends, we must work together to prevent such a catastrophe. We must stop the next Middle East war before it starts. The US government must turn over to the United Nations the primary responsibility for resolving the deepening crisis in Iraq, and, immediately thereafter, withdraw US forces from the country. We must also prevail upon the Israelis to sign the Nonproliferation Treaty (NPT) and open all of their nuclear sites to IAEA inspectors. Only then can serious talks begin with Iran and other states to establish a nuclear weapon free zone (NWFZ) in the Mid East so essential to the region's long-term peace and security. 10/26/04 "ICH"
*Mark Gaffney's first book, Dimona the Third Temple? (1989), was a pioneering study of Israel's nuclear weapons program. He has since published numerous important articles about the Mid-East with emphasis on nuclear proliferation issues.
Saturday, November 06, 2004
New York Times: The Dollar's Long-Term Direction: Down
The Dollar's Long-Term Direction: Down
By EDUARDO PORTER and ELIZABETH BECKER
By EDUARDO PORTER and ELIZABETH BECKER
New York Times
November 4, 2004
The election drove the dollar all over - down when it looked like President Bush would lose, up briefly when Senator Kerry conceded defeat.
But ultimately, the dollar's fate never hinged on the outcome of the presidential election. Now that the dust has settled, the currency is back on its long-term path: downward. According to most economists, it is likely to stay there over the next four years.
"There is a certain inevitability to the decline,'' said Alan Blinder, an economist at Princeton University who served as vice chairman of the Federal Reserve and was an adviser to President Bill Clinton. "I think the Treasury understands this. It would be nice if they would say so."
Managing this potentially painful move will be a pressing challenge for Mr. Bush's economic team. The nation's current account - the broad gap between the nation's exports and imports of goods and services - has reached a deficit of nearly $600 billion, almost 6 percent of the nation's overall economic activity. And it shows no signs of diminishing on its own.
Closing this gaping hole will overshadow the administration's trade policy, coloring its push for better access to foreign markets for American products, and adding urgency to its attempts to make China and other Asian nations revalue their currencies against the dollar so that American industry can be more competitive.
Today, the dollar is at the center of a delicate interlocking web of international financial imbalances. The United States imports much more than it exports. Asian countries - some of the biggest exporters - send the proceeds back into the United States by investing here, mostly in government bonds. That keeps interest rates low, fueling spending and leading Americans to import even more goods and services from the rest of the world.
Both sides benefit from this arrangement. The Asian money allows Americans to spend beyond their means. At the same time, dollar purchases by Asian central banks depress the value of Asian currencies, stimulating their exports to the American market.
An influential group of economists has argued that there is no reason that this imbalance cannot go on relatively undisturbed - if not forever, at least for a very long time. But most mainstream economists argue that, at a minimum, the unraveling of this web would send the dollar lower and squeeze American consumption.
Kenneth Rogoff, a professor of economics at Harvard, said that to smoothly and significantly narrow the current account deficit requires a depreciation of at least 20 percent in the dollar, making it much more costly for Americans to buy imported goods and travel abroad.
The imbalance is fueling a stupendous buildup of foreign debt in the United States. At the end of last year, the nation's net financial deficit - broadly, what Americans owe the rest of the world minus what the rest of the world owes to the United States - amounted to nearly 30 percent of total output. And both sides are digging themselves deeper into holes, with American debts mounting and foreigners acquiring ever greater piles of depreciating paper assets.
Economists who speak of the current account deficit often quote the economist Herb Stein: "If something cannot go on forever, it will stop.''
So what will it take for the brakes to be applied? Barry Eichengreen, a professor of economics at the University of California, Berkeley, argues that Asian policy makers are going to force a change. He contents that as they move away from their present export-led growth strategies, which require cheap currencies, to focus monetary policy on managing internal demand, Asian governments will support the dollar less, buy fewer Treasury bonds and shift some of their foreign reserves to other currencies, like euros.
Indeed, China's decision to raise interest rates last week put upward pressure on the yuan and indicated a willingness to take market-based measures to cool its galloping economy.
"Asian policy is changing," Mr. Eichengreen said. "The end is growing increasingly near."
This suggests that President Bush's efforts to maintain open markets will increasingly be up to others. The United States' leading trade partners - Europeans, Asians and even Canadians - are promising more challenges to Washington on trade issues, bringing disputes to the World Trade Organization and going after new markets as well.
A cheaper dollar would stimulate American exports but would create some conflicts with other countries. And a dollar depreciation, on its own, would do little to curb the nation's dependence on foreign money. For a devaluation to work effectively, economists explain that other measures to reduce the nation's excess spending are needed as well.
The situation, some suggested, is analogous to the problems faced by Ronald Reagan early in his second term, when the United States, despite robust growth, suffered from an expensive dollar, weak exports and big deficits.
In 1986, the administration negotiated the Plaza Agreement with six other major industrial powers, helping pave the way to a manageable, if sometimes rocky, 40 percent decline in the value of the dollar.
"We have to do something similar to get the value of the dollar down and not wait for a market adjustment which could be more damaging to the economy," said Robert E. Scott, of the liberal Economic Policy Institute in Washington.
The strategy worked for Mr. Reagan because he also pushed through a couple of tax increases that helped narrow the budget gap. Economists are not very confident, however, that a second Bush administration would be prepared to do something similar.
That could leave the economy vulnerable to a more painful adjustment, with the dollar falling rapidly and interest rates rising fast. The result would almost certainly lead to a recession and perhaps a collapse in the real estate market.
"There is a real possibility,'' Catherine Mann, an economist at the Institute for International Economics, wrote in a study earlier this year, "that the entanglements created by this co-dependency cannot be undone by anything short of a global economic crisis."
Businessweek: A Windfall from Foreign Bonds
A Windfall from Foreign Bonds
Arthur Steinmetz of Oppenheimer International Bond Fund explains why he likes fixed-income securities from emerging markets
Despite the risks, foreign bonds have paid off in recent years for investors willing to weather volatility in exchange for higher returns. Oppenheimer International Bond/A (OIBAX ), managed by Arthur P. Steinmetz, head of Oppenheimer's international fixed-income team, looks for value and yield in both developed and emerging markets around the globe.
For the 12-month period ended Sept. 30, the $1.6 billion portfolio rose 11.6%, vs. 6% for the average global fixed-income fund. For the three-year period, the fund gained 18.2% annualized, vs. 9.1% for the peer group. For the last five years, it has risen 12.8% annualized, vs. 6.5% for its peers.
Given that Oppenheimer International Bond can invest in emerging markets, the portfolio is more volatile than its peer group, which is illustrated by its higher standard deviation. It also has a substantially higher annual turnover rate. The fund's expense ratio of 1.22%, however, is below the 1.29% peer group average. Based on risk and return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 Stars.
Steinmetz took over as sole manager in April, 2004, following the departure of Ruggiero de Rossi. However, Steinmetz has been on the management team in one capacity or another since the fund's inception in June, 1995. He also manages the Oppenheimer Strategic Income Fund (OPSIX ).
Palash R. Ghosh of Standard & Poor's Fund Advisor recently spoke with Steinmetz about the fund's investing strategy and top holdings. Here are edited excerpts of their conversation:
Q: How does the performance of foreign bonds correlate with the performance of U.S. securities?
A: There's actually a very high correlation between domestic bonds and the fixed-income markets of most of the developed world. For example, in 1994, U.S Treasuries sold off dramatically when the Federal Reserve enacted an aggressive tightening campaign. Interestingly, the German bond market also sold off by about 90% as much as the U.S., even though the German Bundesbank didn't move interest rates at all.
One major exception to this rule is Japan. Japanese bonds do not correlate with our markets, given that their business cycle has been out of whack with global economies for the past 15 years.
Q: What about emerging markets?
A: Emerging-markets bonds also have a low correlation with U.S Treasury bonds because they essentially provide a credit spread. By investing in emerging-markets securities, we add diversification to our portfolio and some protection against changes in U.S. markets.
However, most of the diversification that foreign bonds provide [to] investors comes from taking on currency exposure, and this is central to our investment philosophy.
Q: How do you assemble your portfolio?
A: We seek to create a broadly diversified portfolio by country, region, and currency to minimize volatility. We invest in both developed countries and the emerging markets. Our exposure to emerging markets provides us with a bit more yield than funds that invest exclusively in developed nations.
Essentially, through our investments, we're seeking an income advantage over U.S. markets. Currency is the most important variable in the construction of our portfolio. On a top-down, macroeconomic basis, the three most important global currencies are the U.S. dollar, the euro, and the yen. We evaluate the relationships between these three. The relative strengths and weaknesses of other currencies are of less significance.
Q: How is the fund currently positioned?
A: This fund operates on three different types of risk: interest rate risk, credit risk, and currency risk. At the moment, we're underweight in credit risk, underweight in interest rate risk -- by moving to shorter durations -- and overweight in currency risk.
Q: Do you invest in sovereign bonds or corporate bonds?
A: We're free to invest in both sovereign and corporate bonds. However, in practice, we usually have no exposure to corporates. The primary drivers of return are from currency risk and sovereign credit spreads. Any additional money we might make from buying high-grade corporate bonds would not enhance our overall returns.
We also avoid emerging-markets corporate bonds because they're especially problematic. The credit spread that these issues trade at doesn't compensate for the probability of a sovereign or corporate blow-up in these volatile markets. We find vastly better value and liquidity in sovereign bonds.
Q: What's your currency allocation at present?
A: We have about a 53% exposure to developed-market currencies, emerging markets denominated in U.S. dollars account for 19%, local emerging-markets currencies, 7%, and 10% is in U.S. currency.
We actually have an underweight in dollar-denominated emerging-markets bonds because we thought that rising U.S. interest rates would be a problem for the emerging markets and present a credit risk, but that has turned out not to be the case thus far.
Q: How has the portfolio changed over the last year?
A: We've reduced our interest rate duration as rates declined in the U.S. We've increased our exposure to emerging-markets bonds denominated in local currency, notably in Turkey and Brazil. We like countries with high real returns and declining inflation. Q: What is the fund's average credit rating?
A: It is currently at A+, but typically it's not that high since we're willing to invest in both emerging-markets bonds and below-investment-grade bonds. However, keep in mind that many emerging-markets bonds have witnessed upgrades to their sovereign debt in recent years.
Q: This fund generated big returns in 2002 (20.8%), and 2003 (25.9%). What drove this outperformance?
A: In 2002, we got big performance from emerging-markets bonds. In 2003, it was a combination of the continuing strength of emerging-markets bonds and the sustained weakness of the U.S. dollar.
Q: Why does the fund have such high annual turnover rates, as much as 300%?
A: The high turnover is a result of our investment methodology, and we think it's a spurious number. Currency hedging and active currency overlays are usually done on a 1- to 3-month rolling basis. Therefore, simply maintaining the positions requires several rolls per year, which inflates the turnover figure.
Q: Do you expect foreign bonds to outperform U.S. bonds as we head into next year?
A: Yes, and for two reasons: rising interest rates in the U.S. and the necessary correction in the U.S. dollar, which is ongoing. Interest rates are falling around the world, outside of the U.S. European bonds perform particularly well when the U.S. dollar weakens.
Despite the risks, foreign bonds have paid off in recent years for investors willing to weather volatility in exchange for higher returns. Oppenheimer International Bond/A (OIBAX ), managed by Arthur P. Steinmetz, head of Oppenheimer's international fixed-income team, looks for value and yield in both developed and emerging markets around the globe.
For the 12-month period ended Sept. 30, the $1.6 billion portfolio rose 11.6%, vs. 6% for the average global fixed-income fund. For the three-year period, the fund gained 18.2% annualized, vs. 9.1% for the peer group. For the last five years, it has risen 12.8% annualized, vs. 6.5% for its peers.
Given that Oppenheimer International Bond can invest in emerging markets, the portfolio is more volatile than its peer group, which is illustrated by its higher standard deviation. It also has a substantially higher annual turnover rate. The fund's expense ratio of 1.22%, however, is below the 1.29% peer group average. Based on risk and return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 Stars.
Steinmetz took over as sole manager in April, 2004, following the departure of Ruggiero de Rossi. However, Steinmetz has been on the management team in one capacity or another since the fund's inception in June, 1995. He also manages the Oppenheimer Strategic Income Fund (OPSIX ).
Palash R. Ghosh of Standard & Poor's Fund Advisor recently spoke with Steinmetz about the fund's investing strategy and top holdings. Here are edited excerpts of their conversation:
Q: How does the performance of foreign bonds correlate with the performance of U.S. securities?
A: There's actually a very high correlation between domestic bonds and the fixed-income markets of most of the developed world. For example, in 1994, U.S Treasuries sold off dramatically when the Federal Reserve enacted an aggressive tightening campaign. Interestingly, the German bond market also sold off by about 90% as much as the U.S., even though the German Bundesbank didn't move interest rates at all.
One major exception to this rule is Japan. Japanese bonds do not correlate with our markets, given that their business cycle has been out of whack with global economies for the past 15 years.
Q: What about emerging markets?
A: Emerging-markets bonds also have a low correlation with U.S Treasury bonds because they essentially provide a credit spread. By investing in emerging-markets securities, we add diversification to our portfolio and some protection against changes in U.S. markets.
However, most of the diversification that foreign bonds provide [to] investors comes from taking on currency exposure, and this is central to our investment philosophy.
Q: How do you assemble your portfolio?
A: We seek to create a broadly diversified portfolio by country, region, and currency to minimize volatility. We invest in both developed countries and the emerging markets. Our exposure to emerging markets provides us with a bit more yield than funds that invest exclusively in developed nations.
Essentially, through our investments, we're seeking an income advantage over U.S. markets. Currency is the most important variable in the construction of our portfolio. On a top-down, macroeconomic basis, the three most important global currencies are the U.S. dollar, the euro, and the yen. We evaluate the relationships between these three. The relative strengths and weaknesses of other currencies are of less significance.
Q: How is the fund currently positioned?
A: This fund operates on three different types of risk: interest rate risk, credit risk, and currency risk. At the moment, we're underweight in credit risk, underweight in interest rate risk -- by moving to shorter durations -- and overweight in currency risk.
Q: Do you invest in sovereign bonds or corporate bonds?
A: We're free to invest in both sovereign and corporate bonds. However, in practice, we usually have no exposure to corporates. The primary drivers of return are from currency risk and sovereign credit spreads. Any additional money we might make from buying high-grade corporate bonds would not enhance our overall returns.
We also avoid emerging-markets corporate bonds because they're especially problematic. The credit spread that these issues trade at doesn't compensate for the probability of a sovereign or corporate blow-up in these volatile markets. We find vastly better value and liquidity in sovereign bonds.
Q: What's your currency allocation at present?
A: We have about a 53% exposure to developed-market currencies, emerging markets denominated in U.S. dollars account for 19%, local emerging-markets currencies, 7%, and 10% is in U.S. currency.
We actually have an underweight in dollar-denominated emerging-markets bonds because we thought that rising U.S. interest rates would be a problem for the emerging markets and present a credit risk, but that has turned out not to be the case thus far.
Q: How has the portfolio changed over the last year?
A: We've reduced our interest rate duration as rates declined in the U.S. We've increased our exposure to emerging-markets bonds denominated in local currency, notably in Turkey and Brazil. We like countries with high real returns and declining inflation. Q: What is the fund's average credit rating?
A: It is currently at A+, but typically it's not that high since we're willing to invest in both emerging-markets bonds and below-investment-grade bonds. However, keep in mind that many emerging-markets bonds have witnessed upgrades to their sovereign debt in recent years.
Q: This fund generated big returns in 2002 (20.8%), and 2003 (25.9%). What drove this outperformance?
A: In 2002, we got big performance from emerging-markets bonds. In 2003, it was a combination of the continuing strength of emerging-markets bonds and the sustained weakness of the U.S. dollar.
Q: Why does the fund have such high annual turnover rates, as much as 300%?
A: The high turnover is a result of our investment methodology, and we think it's a spurious number. Currency hedging and active currency overlays are usually done on a 1- to 3-month rolling basis. Therefore, simply maintaining the positions requires several rolls per year, which inflates the turnover figure.
Q: Do you expect foreign bonds to outperform U.S. bonds as we head into next year?
A: Yes, and for two reasons: rising interest rates in the U.S. and the necessary correction in the U.S. dollar, which is ongoing. Interest rates are falling around the world, outside of the U.S. European bonds perform particularly well when the U.S. dollar weakens.
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