Thursday, September 30, 2010

Choose Your Confetti

Race to Debase, Part Deux:

[Wall Street Journal, 09-29-2010]

"Tensions are growing in the global currency markets as political rhetoric heats up and countries battle to protect their exporters, raising concerns about potentially damaging trade wars."

Tuesday, September 28, 2010

Tuesday Twosome

Rex Fowler and Neal Shulman

Aztec Two-Step

Let It Be Me

Thursday, September 23, 2010

War By Other Means

Chinese Premier Wen Jiabao is sitting on a powder keg. He knows it, and he wants U.S. government officials to know it, too. The U.S. is pressing China to revalue its currency upward relative to the dollar as a way to redress the huge trade imbalance between the two countries. That would mean more jobs in the U.S., fewer in China. Good for us, bad for them.

“We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside, ” said Wen last night in New York. If the yuan were allowed to appreciate by 20 percent to 40 percent, “China would suffer major social upheaval.”

Similarly, Japan is relying on a cheap yen to boost its own exports. Twice this week Japan has intervened in foreign-exchange markets, dumping yen to weaken the currency against the dollar. Not to be outdone in the race to debase, Federal Reserve Chair Ben Bernanke hinted earlier this week that the Fed was contemplating another $1 to $2 trillion in quantitative easing to goose the U.S. economy. Should QE2 set sail (after the November elections?), the dollar would lose value in the currency markets. First currency to the bottom wins. "No country wants a strong currency," observes David Rosenberg at Gluskin Sheff. "All we have seen this year, and the past few years in fact, is a series of rolling bear markets in various currencies."

As for the Fed's next intervention, Minyanville's James Kostohryz explains, "the Fed pretty much must expand its balance sheet in order to avoid an economic contraction." Continuing:

A crowding out of credit to the private sector [by federal deficit spending] would obviously have deflationary consequences. In a modern economy, characterized by fractional reserve banking and highly leveraged financial institutions, even a modest contraction of credit to an important sector of the economy can produce a severe system-wide contraction of liquidity (available money). This point was amply proven in late 2008 and early 2009 when the contraction of credit to some sectors of the economy produced a massive economy-wide liquidity squeeze. This is the money multiplier effect in reverse. Thus, many Fed officials feel that they must avoid such a deflationary crowding out by 'accommodating' the expansion of fiscal deficits [i.e. purchasing U.S. Treasuries].

And how about the European periphery (a.k.a. "PIIGS")? How are those currencies doing? Glad you asked. Examining the chart below, we can see that the interest-rate spread between Portuguese and German 10-year bonds has surged to over 400 basis points:

Difference in rates for the Portuguese 10-year and the German bund

Ditto the spread between Irish and German bonds:

Difference in rates for the Irish 10-year and the German bund

As you can see, the spreads exceed the flash-crash highs of last May, when the prospect of sovereign defaults started to get serious attention. The higher the spread, the greater the perceived risk of default. The fear is that the first default will trigger a chain reaction, crushing the currencies of those nations (including the U.S.) lugging the heaviest debt loads.

If it gets that far, it will be every nation for itself, a gloomy scenario indeed.

[update, 09-24-10:]

In its race to the bottom, the U.S. dollar this morning has hit another record low against the Swiss franc, one of the few stable currencies left.

number of dollars needed to buy one franc

[update, 09-27-10:]

Brazilian Finance Minister Guido Mantega:

"We're in the midst of an international currency war.
This threatens us because it takes away our competitiveness.
The advanced countries are seeking to devalue their currencies."

Tuesday, September 21, 2010

U.S. Debt: Just How Big?

Morgan Stanley's London office has issued a new publication, Sovereign Subjects, which focuses on sovereign risk in advanced economies. The question addressed: how likely is it that the western nations will restructure their debt? Any such action will penalize the holders of sovereign bonds.

So far investors in U.S. Treasury bonds seem unconcerned. They have been relentlessly bidding up bond prices since last spring. The yield (which moves inversely to price) on the ten-year bond has gone from 4% to well under 3% in a matter of months--and seems headed to 2% or less. Indeed, there has been talk of a "bubble" in bonds.

By one measure, the debt-to-GDP ratio (lefthand column in the table above), U.S. Treasuries appear to offer a safe haven relative to the bonds of the Club Med nations, or PIIGS. But debt-to-revenue ratios (righthand column) suggest that, absent any tax increases, the U.S. is in a poor position to service its debt.

Add in future liabilities not now captured in national accounts, and you end up with some pretty ugly-looking balance sheets:

A government with negative net worth, in the words of Morgan Stanley's Arnuad Mares, "is insolvent. In other words, some or all of its stakeholders must suffer a loss: either taxpayers (through a higher tax burden), or beneficiaries of public services (through lower expenditure) or bond holders (through some form of default)." Continuing:

"Against this background, it seems dangerously optimistic to expect that sovereign debt holders can be continuously and fully sheltered from partaking in the loss of wealth and income that has affected every other group. Outright sovereign default in large advanced economies remains an extremely unlikely outcome, in our view. But current yields and break-even inflation rates provide very little protection against the credible threat of financial oppression in any form it might take."

Mares does not believe that sovereign bondholders are being adequately compensated for the risk that they are taking on. Once that perception gains traction in the investor community, there will be a stampede to the other side of the boat. Then watch what happens to the federal deficit when interest rates spiral upward.

Tuesday Twosome

Bob Dylan and George Harrison

If Not For You

Monday, September 20, 2010

Wind Power: "small" and "incremental"

Financial Times interviews John Rowe,
CEO of utility giant Exelon
[ten minutes]

Rowe explains that natural gas will be "the dominant fuel on the margin" for the next 10-20 years because supplies are abundant, gas-fired generation has a low capital cost, and gas emits half the carbon of coal per kilowatt-hour generated. With the overall demand for power growing at less than 1% annually in the U.S., the nuclear-power industry is basically "stagnant." Wind and solar are even "more uneconomic" than nuclear. Whatever incremental investment goes to wind and solar will be driven more by public policy than by market forces. As older coal plants are decommissioned, gas-fired generation will be Exelon's "first response" to replace lost capacity.

The price of natural gas remains a tad under $4 per million BTUs and has not advanced since Angus King of Independence Wind LLC announced almost a year ago a delay in construction of Roxbury's Record Hill wind farm. King said at the time that it was tough to compete with four-dollar gas. It is no easier today. If Rowe is correct, it will be no easier for at least another ten years.

JAARS Pilots Visit the River Valley

Helicopter pilot Nard Pugyao at Zinck's airfield, Rumford
September 19, 2010

Earlier in the day Nard (a native Filipino) gave a talk much like this one at the Mexico First Baptist Church.

Tuesday, September 14, 2010

Tuesday Twosome

Chad Stuart and Jeremy Clyde

A Summer Song

Monday, September 13, 2010

A Pro's View on Pension Assets

Donald Coxe, chief investment strategist at Coxe Advisors LLP, has renewed his warning in his "Basic Points" for September 2010 that pension funds will have a difficult time generating positive returns in the years ahead. First of all, the Federal Reserve's Zero Interest Rate Policy (ZIRP) on short-term debt is hitting bond investors hard. Those who traditionally depend on fixed-income markets for returns are being "systematically sacrificed" in the government's effort to protect homeowners and lenders who took on too much risk during the housing bubble. Writes Coxe, "the longer this Japonisation of the debt markets continues, the greater the debilitation of the pension systems -- public and private -- across North America."

So where is a fund manager to turn? Coxe points out that U.S. stocks have been a loser, with the S&P 500 down by a third in the past decade. He sees that underperformance continuing. He recommends that U.S. pension funds commit only 17% of their total portfolio value to U.S. stocks (MainePERS, at 33.2%, had nearly double that exposure as of June 30, 2010). Another 20% should go to foreign stocks (MainePERS was at 25.7%). Coxe likes commodities (especially precious metals) and commodity stocks and would put another 12% there. He considers long-dated bonds to be relatively safe and recommends a total bond exposure of 41% (compared to Maine's 29.5%). Finally, he feels better with 10% in cold cash (Maine's stated target is 0%).

Coxe is particularly sour on financial stocks and urges an underweight there. "If U.S. house prices fall a further 10-20%," states Coxe, "the increase in putrescent assets on banks' balance sheets will overwhelm the writedowns to date." Alas, as I detailed here, MainePERS owns a boatload of wasting assets in this sector. Coxe would argue that the MainePERS portfolio is in need of an extreme makeover, sooner rather than later.

MainePERS Portfolio, 06-30-2010

[update, 09-16-10:]

On the prospect for home prices, Rick Sharga, senior vice president at RealtyTrac, told Bloomberg in a telephone interview that "we're on track for a record year for homes in foreclosure and repossessions." Bank repossessions of homes occupied by delinquent borrowers climbed to a record 95,364 in August, up 25% from a year earlier. The number of new default notices (Step One in the foreclosure process) declined to 96,469. But Sharga believes that banks are holding back so as not to flood the market. "If the market is left to fend for itself, you may see more serious price depreciation," he said. "Whether things fall precipitously depends on government and lenders controlling the inflow of new foreclosure actions."

Backpacking on the GLT

Cherri Crockett on the Grafton Loop Trail
August 2010
Story here.

Limits to Earth's Resources

What's Left?Powered by Ergo:Ux

Click here for an interactive slide show at Scientific American.

Thursday, September 9, 2010

Meltdown, Part One

Coming to a theater near you.

We're Number One! ranks the G-20 nations for obesity.
[Go here.]

“The costs of medical care linked to obesity are enormous, reaching $150 billion a year in the U.S. We are moving to a situation where diabetes is becoming a normal part of human existence.”

--Thomas Farley, New York City's health commissioner

David Kessler, former head of the US Food & Drug Administration, addresses the issue in his book The End of Overeating: Taking Control of the Insatiable American Appetite.

Rev's Ride Jacked: the Work of Eco-Terrorists?

"Honey, they shrunk my car!"

"The Reverend Jesse Jackson’s Caddy Escalade SUV was stolen and stripped of its wheels while he was in town last weekend with the UAW’s militant President Bob King leading the “Jobs, Justice, and Peace” march promoting government-funded green jobs. Read that again: Jackson’s Caddy SUV was stripped while he was in town promoting green jobs.

Add Jesse to the Al Gore-Tom Friedman-Barack Obama School of Environmental Hypocrisy. While preaching to Americans that they need to cram their families into hybrid Priuses to go shopping for compact fluorescent light bulbs to save the planet, they themselves continue to live large.

--Henry Payne, The Michigan

[Thanks to Richard Begin for passing this on.]

Tuesday, September 7, 2010

Loon Ranger

Derrick T. Jackson of the Boston Globe gives an update
on how Lake Umbagog's loons are doing.

[Click on slides 8 through 14, starting here.]

One chick in eighteen has survived--and this was a good year!

Tuesday Twosome

Kenny Loggins and Jim Messina

A Love Song

Monday, September 6, 2010

Mt. Abraham

Earlier today, at the summit of Mt. Abraham

Sugarloaf (and Bigelow beyond) from Mt. Abraham

View of Mt. Abraham from Sugarloaf

Friday, September 3, 2010

Don't Get Excited

Wall Street is carrying on as if we have turned the corner in the Jobs Department. The U.S. Bureau of Labor Statistics this morning released its monthly assessment of the Employment Situation (as in, we have a "situation" here), and the numbers were not quite as bad has had been feared in the days leading up to the announcement. The private sector actually created 67,000 jobs in August, though that number was more than offset by the loss of temporary census jobs, resulting in a negative net number (-54,000). That was only half the whisper number, so--wooHOO!--let's party.

Even a cursory glance at the chart above shows that the current malaise bears no resemblance to a typical post-WW2 recession. The losses are steeper, and the recovery will be more protracted. The total number of jobs in the economy is little changed from a year ago and down from three months ago, when the fertilizer got taken away from all those green shoots. Looking at the Household Survey data, David Rosenberg of Gluskin Sheff counts over a quarter-million full-time jobs lost in August. Rosenberg, derided as a perma-bear, no longer talks about a double dip. He looks at a chart like the one above and calls it a "single scoop" instead.

Put away the vuvuzelas.

[update, 09-07-10:]

"At the end of the day, the real mystery is why presumably numerate Wall Street economists and strategists have taken any comfort at all from the modest blip in the headline job count since last December. An economy that shed more than 8 million jobs during the two-year recession has now recovered the grand sum of 425,000 positions outside of the HES Complex [health, education, and social services], Core Government Operations, and the soon-to-be-completed 2010 Census.

Among this miniscule total, there were 160,000 half jobs in the leisure and hospitality sector, and 200,000 jobs at temporary employment agencies. These are the lowest paying, least stable jobs in the entire economy, and can't conceivably serve as a foundation for the recovery of private incomes and spending."

--David Stockman, "Now the Bad News: Those August Jobs Were Rented" [full article]

Thursday, September 2, 2010

How Does Maine Rate?

It is no secret that states are staggering under the prospects of revenue shortfalls and looming unfunded liabilities. Bondholders concerned about the possibility of default have begun to buy insurance in the form of Credit Default Swaps (CDS), which guarantee the proceeds expected at maturity. The chart above, released Monday by Bespoke Investment Group, displays the "premiums" for such coverage. The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years. The higher the price, the higher the default risk.

So how risky are Maine's bonds? Moody's and Fitch have recent upgraded their ratings of our bonds to AA2 and AA+ respectively, but Standard & Poor's reiterated its
negative outlook three months ago, much to the consternation of State Treasurer David Lemoine, who bemoans the higher cost of borrowing occasioned by the lower rating. In a letter to S&P dated June 9, Lemoine pointed out that "the people of Maine have a one hundred and ninety year history of issuing state general obligation bonds without default, a constitutional mandate to pay bond holders in full before any other state expenditure can occur, and a state government with current revenue expectations at twenty-five times general obligation debt service"--all signs of creditworthiness. But "history" these days quickly becomes ancient. An unprecedented pension liability, exacerbated by an eroding investment portfolio, is not likely to persuade S&P to change its outlook anytime soon.

As for the price of protection, Lemoine professes in an e-mail earlier today to know nothing of "the nature or make-up of a muni CDS market." Having been burned in 2007 for investing nearly $20 million of Maine's Cash Pool (back when we
had a cash pool) in risky derivatives, Lemoine no longer plays with those matches. But even if he himself neither buys nor sells swaps, the suspicion remains that somebody does. Again, at what price?

Wednesday, September 1, 2010

Like Dominoes

[click to enlarge]

Yesterday the Federal Deposit Insurance Corporation
(FDIC) released its Quarterly Banking Profile, evaluating the health of the commercial banking industry. The FDIC oversees over 7,000 banks; as of the end of June, 829 of them were categorized as "problem banks" at risk of failure. That number is up by 127 since the end of 2009 and does not include the 86 banks that were closed from January to June. In July and August 32 more banks have failed, raising the total cost to the Deposit Insurance Fund to almost $19.5 billion in 2010.

Aggregate loans and leases fell by $95.7 billion, or more than one percent, as banks continued to shrink their balance sheets. It was the fifth quarter out of the last six in which banks' assets declined, further evidence that the economy is contracting.

Although the FDIC's press release hailed the improved profitability of the industry, Peter Atwater, President and CEO of Financial Insyghts, remains skeptical. He believes that the $21.6 billion in combined profits for Q2 are largely illusory. Even the FDIC admits that "the primary factor contributing to the year-over-year improvement in quarterly earnings was a reduction in provisions for loan losses." At the end of June, loan-loss reserves totaled 65% of non-current loans.

"Personally," says Atwater, "I think the industry needs something closer to 80% coverage of non-current loans given our high unemployment and underemployment rate and the deflationary environment impact on underlying loan collateral." That would call for another $50 billion in reserves, offsetting reported Q2 profits by a ratio of more than 2:1.

According to the St. Louis Federal Reserve, allowances for loan and lease losses (ALLL) industrywide stand at less than 20% of all nonperforming loans:

Mike Mish Shedlock suspects that the problem is worse than what the FDIC is reporting. In his article "Something's Not Right With Report's Loan Loss Data," he quotes a commercial banker in California as follows:

In my estimation, if every bank had the collateral of all loans accurately appraised and each loan’s loan grading was finely tuned for an expected loss based on financial performance and collateral values, the number of essentially bankrupt banks in this county would increase by a factor of four to five from the current level.

In other words, there is a potential pool of 2,000 to 3,000 banks that would be on the FDIC's radar for getting closed.

The health of the industry is not accurately reported by any means.

Reminder: the MainePERS portfolio is still over-exposed to the banking sector, which means the hits will keep on comin'.