THE GLOBAL ECONOMIC FRONT

LATEST PERTINENT FACTS ON THE GLOBAL ECONOMIC FRONT

People at large know generally that the globe is facing economic downturn and Europe as a whole is in a dilemma over debt doldrums that may likely cause the region to go bust. They have heard of the possible breakup of the Eurozone pact if the various governments could not reach a consensus on measures to resolve the economic crisis enveloping debt-ridden members. They have also read news about USA trying ways and means to stimulate its economy and reduce unemployment rate albeit without much noticeable success so far. But apart from the broad overview scenarios, most people do not fully understand specific facts entailed in the issues surrounding the crisis.

Based on personal research, I am pleased to render some pertinent and some interesting details of developments for your fuller comprehension.

ON OPERATION TWIST:                  

          

Twister and singer Chubby Checker became famous by his hit song “Let’s Twist Again” in 1961. Still a favourite oldie, the lyrics begin with “Come on, let’s twist again, like we did last summer; come on, let’s twist again, like we did last year.” Like the beginning lyrics of the song, the US Federal Reserve (US Fed) recently went for the twist again…….by announcing the extension of OPERATION TWIST until the end of the year from the original expiry at the end of June.

What is Operations Twist and what is the mechanism?

In extending the programme until the end of this year, the Fed is set to sell US$267 billion of shorter-term securities and then buy longer-term bonds. In essence, the Fed is selling treasury securities it owns that mature in less than three years to buy longer-term bonds maturing in six to 30 years. It will also reinvest proceeds from its mortgage-backed securities that mature into new ones. By buying longer-term papers, it aims at lowering longer-term interest rates and thus encourages more borrowing and spending. Theoretically, lower rates could also stir up investments in stocks because investors will receive less return on investments in treasury bonds. Also, by reinvesting proceeds from matured mortgage-backed securities into new ones, it supports the housing market. (Source: AP News).

The question of whether Operations Twist would work significantly to boost growth is yet to be tested for effectiveness. Interest rates in the US are already low, so some economic pundits feel the programme may not lead to vibrant rise in more borrowing for purpose of investment and higher consumption.

ON QUANTITATIVE EASING (QE):

The much anticipated QE3 implementation by the US Fed, which many economic pundits have been touting around, should fizzle out with Operations Twist coming into the picture.  If QE1 and QE2 had not been successful to revive the US economy to noticeable levels, what guarantee another round of QE will do so? M. Ramsey King Securities Inc., in its report of June 21, wrote: “Once again, the braying QE chorus has come up empty. For over a year, we have maintained that there will be no QE 3.0 unless there is a system or a big bank problem. The Fed must save its sole bullet.“ The report added: “The Fed reiterated the trite global central bank oath: It stands ready to take further action if needed.” It looks like that is all talk about QE for now.

Many analysts contend that the past two QEs involved the Fed “printing” more money to buy treasury bills/notes/bonds, thus flooding the market with new US dollars. According to a website, from November 2010 to March 2011 the government printed about US$70 billion a month under QE2 and bought treasury bills with the hope of stimulating the economy, but the hope did not turn out as expected.

A business magazine website said QE was formulated with the notion that the US Fed could stimulate spending. But that did not happen because banks used the new money to build up reserves rather than lend.  Without increasing credit, there would be negligible effect on driving growth activities. Yet, some economists postulate that stocks and commodities will not reverberate vibrantly without another round of QE and they still anticipate it would be a matter of time (soon?) for QE3 to be implemented.

ON GOLD:

Gold represents the alternative safe haven to USD, the international currency. Historically, the price of gold in USD fluctuated inversely to the strength of the American currency, i.e. gold price normally soared when USD weakened, and vice versa. Similarly, gold prices portray a good indicator of the health of the US economy – the No. 1 global economy till today, thus when the price of gold is high, that signifies the US economy is not so healthy whereby investors flock to gold to protect their investments from a looming crisis or inflation. Inversely, when gold price drastically drops, it may mean investors moving out of gold for other investments like stocks or real estates because of expected market vibrancy. 

And what is the correlation between gold prices and QE measures in the US? Logically, QE would weaken the USD and hike inflation. QE could be deemed as a signal that the No. 1 global economy is not in good shape. QE would normally trigger investors’ demand for gold as the alternative safe haven.

Three interesting events have taken place pertaining to gold in the two large Asian nations – India and China – and the US.

According to a gold forecast website (June 30), the Reserve Bank of India was considering a ban on the sale of gold coins by banks in that country. The report said it was partly an attempt by the Reserve Bank to curb rising gold imports. Meanwhile, the Rupee remained weak even after the Reserve Bank had increased the amount of Indian debt that could be held by foreigners. The report added that the intended implementation would not be favourable to 36 banks already nominated by the apex bank to import gold into the country, and would invariably cut off about US$26 million in commission/profit earned by the sales.

An interesting development has emerged in the China gold scene. An economic newsletter on June 6 quoted the Hong Kong Consensus and Statistics Department for having reported that China imported a massive amount of gold. In the first week of June itself, 104 tons were sourced from Hong Kong. In the first four months of 2012, Chinese imports from Hong Kong totalled 239 tons – a whopping 782pc. increase year-over-year. The newsletter claimed China preferred to be silent about the action. Apparently, said the newsletter, the Chinese leaders desired to reduce the country’s exposure to US dollar-based assets besides losing appeal to euro-based bonds. A further observation: the Chinese were importing gold bullion rather than buying up gold mining stocks. Ironically, China is already the largest producer of gold globally. So, it seems that in addition to its large supply of gold from internal sources, they are “hoarding in” a significant amount of the rest of the world’s mining production. There must be something up in the sleeves of the Chinese policymakers…….but what? If I can secure more information in this respect, I will share with you in one of my future blog postings. 

In the US, the latest gold news is good news to banks there. The relevant authority is intending to treat gold bullion as a Tier 1 Asset for banks; meaning gold bullion held in bank vaults will be accorded “zero-risk-weight” rating asset against which they need not set aside any regulatory capital. As it stands now, gold has a 50pc. risk-weighting.

Big question: Can global gold supply cope with global demand if the later continues to be on the surging trend in the long run? While the mining industry has made some resounding strides since its 2008 production low, yet the future picture of gold production may not be bright, according to a news report by The Telegraph. Excerpts from the report:

# Global gold production is in terminal decline despite record prices and herculean efforts by mining companies to discover fresh sources of ore in remote spots (quoted Barak Gold, the world’s top producer).

# Total mine supply has dropped by 10pc as ore quality erodes.

# Production peaked around (year) 2000 and it has been in decline ever since. ……..forecast that decline to continue. It is increasingly difficult to find ore (quoted an officer of Barak Gold).

Meanwhile, this year’s gold price trajectory looks like heading to the US$1,600/1,500 levels. After reaching all-time high of $1,895 on Sep. 5 last year caused by poor jobs report, the Eurozone crisis and the US debt ceiling issue, the projectile has scaled down. As reference, here is the list of highest price of each month from January to July 2:

Jan. 27 (1,739.09); Feb. 23 (1,779.20); Mar. 1 (1,718.70); Apr. 2 (1,676.35); May 1 (1663.16); June 18 (1628.10); July 2 (1597.55).

(Source: BullionVault.com) 

A gold forecast website expects gold prices ending each month from July to November as follows: July (1,653); Aug. (1,683); Sep. (1,647); Oct. (1,626); Nov. (1,553).

Although prices may be volatile for 2012, many analysts propound that buying gold to hold for long term may be a choice of foresight. However, my friend Chan Cheh Sing (he is in asset management) harbours his firm but interesting perspectives of gold. Let’s see what he says:

“My stance is unchanged. Gold is a merely a proxy to medium of exchange in modern financial transaction model. Gold is irrelevant in modern economic structure. Gold price will fluctuate, but not due to China, India, or whoever is buying for hoarding purpose. Just imagine the day if China owned all the physical gold in the world, so what? Would every country bow to China for gold? No, they would just create or use other metals to replace the little yellow thing. Remember, gold is neither oil, nor water, nor food. Historically, no one goes to a major war just for gold. Two biggest issues gold miners are facing – If gold becomes too important, then gold miners will not be allowed to mine gold; if gold becomes irrelevant to a central bank, gold miners will lose a big customer. Thus, it is the classic “head I win, tail you lose”. Yes, current production may be enough for retail consumption but not for central bank’s hoarding. They can just keep buying……..the question is , what “thing” they use to trade with their gold? Current production is not enough to meet all the “long” contracts (be it futures or spot). If today all “long” contracts are presented to the exchange for banks, I am very sure the bankruptcy lawyer will be very busy.”

Incidentally, a gold investor friend of mine told me just very recently about his experience. He wanted to redeem his gold purchased from a bank with his “paper gold” certificate. He had to wait for some weeks. He believed that the bank had to source for the physical gold when he went for the redemption.  Bear in mind that not many banks in Malaysia have physical gold to offer. The other option, of course, is to buy gold ornaments, if bullions are not easily available.

ON EUROPE:

Relief – at least temporary for now - has been planted amongst the European Union (EU) and  Eurozone (nations using the common Euro currency) members with the conclusion of consensus to channel €500 billion bail-out fund to directly recapitalise ailing banks and stabilise bond markets without adding to government debt. In addition, €120 billion would be devoted to stimulate growth and create jobs. The agreement was arrived at after much haggling and dragging of feet by Eurozone leaders.

Angela Merkel, the Chancellor of Germany, right at onset of deliberations had maintained rigidly in her stance that Germany would object to any further bailout without conditions. In the recent EU Summit, the leaders concurred for the formulation of a banking and fiscal union as the complementary solution. Analysts see this resolution as probably paving the path for European Central Bank (ECB) to become the main supervisor of the bloc’s financial system, with “fatherland” Germany as the overseer or adviser to ECB and the union via its “matriarch” Merkel.  Yet the journey may not be easy as there are a string of questions to tackle first, e.g. which countries should participate in the banking/fiscal union? The United Kingdom (UK) probably will not take part while other non-Euro countries like Sweden have expressed reservations. Which entity – the ECB or another existing institution, or a new institution – should be appointed to supervise banks? What banks should be covered by the banking union – all of them or only the cross-border ones? Which institution should have the final word over national budgets in a political and fiscal union? Who should issue joint Eurozone debt? The leaders and the relevant institutions must quickly settle the nitty-gritty elements in order to revive the spirit of mutual direction for sustainability and stability in Eurozone overall.

 

  (GESTURES OF A DOMINANT PERSONALITY)

 

 Notwithstanding the forward-track possible scene of the region, it is relevant to understand the hitherto backdrop of pertinent events in Europe.

#Although rife talk of Greece exiting from the Euro bloc has subsided of late, some analysts still believe it will ultimately happen. If Greece leaves, it will default; faith in the Eurozone will be shattered. It is estimated that public sector clams against Greece may be around US$450 billion. The exposure of Germany, deemed as the trump card holder of Eurozone, itself is not meagre. Impact on bond markets would be inevitable. A contagious echoing effect may domino across the region. Investors would shy away putting money in high risk nations like Spain, Portugal, Italy etc. which are already seeing high borrowing costs. The chief concern is, after Greece (if it does exit), would more follow suit? Fear of the banking sector landing in disaster would not be unreal, as one large investment banking group portrayed that more than half of the value of European banks could be erased if a departure of the peripheral weaker nations does take place.

#Depositors are taking out their money from banks in Greece. A similar trend is also happening in Spain. Nearly US$40 billion in deposits fled Spanish banks 

#The problems in Eurozone, if persist much longer without significant improvements, would not be confined within the European continent. Bear in mind that 20 pc. of China’s exports go to Europe, and a serious disruption in the EU would affect overall Asia’s exports. The World Bank says European banks provide a third of trade and project finance in Asia. A financial newsletter says: “Europe’s banks dominate emerging market lending and have lent nearly US$6 trillion to the rest of the world, two times the level of US banks."

#Unemployment rate in Eurozone is high – 11.1pc. as at May, with 17.6 million without jobs, up by  88,000 over April and 1.8 million year-over-year.

#Overall Eurozone’s Purchasing Managers Index (PMI) fell to 45.1 in May - the 10^th straight month below the 50 points threshold. Readings above 50 indicate growth environment, conversely those below 50 reflects contraction in manufacturing. 

#Six member countries in Eurozone, including Spain and Italy, are technically defined as in recession. However, Germany’s growth counteracts to prevent the zone as a whole from falling into recession (Source:  Business Times/AP). 

#”Big Brother” Germany, as the dominant economy of the bloc, is not really in a rosy situation. Unemployment rate has increased, standing at 6.8pc. as at June. Information and Forschung (IFO) Institute, a German economic research and think-tank non-profit organisation, describes the economy entering into a “weak phase”. Last year, GDP grew by 3pc. as compared to 3.7pc. in 2010. The services sector stagnated in June as the services PMI fell to 49.9 from 51.8 in May. The Deutsche Borse Group, a leading exchange organisation, on May 11, 2012 forecasted GDP growth to slow down to 0.7pc. this year and then pick up again to only 1.7pc. next year.  Another financial news website says Germany risks to lose more than €700 billion if Greece, Italy, Ireland, Portugal and Spain were to default.

#The Bank of England recently launched a third round of QE amounting £50 billion (as part of the £200 billion stimulus scheme) to buy government bonds, aimed at countering the slowdown in Eurozone countries, Britain’s largest export market. The additional QE adds up to the already to-date £325 billion of government bonds purchase, making the total to £375 billion. The overall QE programme is not working as well as it should. According to Reuters, Business Secretary Vince Cable has observed that banks are failing to lend to small firms in need of loans. Cable feels apt measures should be instituted to focus on how to ensure additional money gets into British businesses.  England fell into recession at the turn of this year.

#Russia, the big brother of the former Soviet Union, is facing economic slide-down too. The Ruble went down 12pc. against USD in May. US$42 billion left the country in the first four months of this year. The World Bank projected its GDP growth to decline from 4.3pc. in 2011 to 3.5pc. in 2012.

ON USA:

The world’s largest economy seems to be faring only a bit better, with the first quarter GDP growth only at 1.9pc. New jobs report for May depicted extremely sub-par, with 69,000 jobs created which was well short of the 150,000 forecast. Unemployment rate has edged back up to 8.2pc., from the improved rate of 8pc. that had been attained few months ago. Obviously, the US Fed Chairman Ben Bernanke and his team are cracking their heads to revitalise the situation there, like “operations twisting” again. So far, no significant achievements have surfaced. On the other hand, a piece of intriguing news has cropped up – that of JPMorgan Chase, its largest financial institution. In June, The New York Times reported trading losses from bungled credit-derivatives of the institution could total as much as US$9 billion, far exceeding earlier public estimates.

Budget deficit is now at around 8pc. – slight improvement from the 9 -10pc. experienced 2 -3 years ago.

ON CHINA AND THE REST OF ASIA:

CHINA: It is still the leading Asian economy and the world’s second largest economy despite experiencing growth slowdown trend against last year. The growth score of 8.1pc for the first quarter of 2012 was the slowest pace since 2009. New medium to long-term business loans from banks went down by 46pc. in April, and trending into May. To prevent the economy from further sliding down, the People’s Bank of China (PBoC), on July 5, reduced interest rate for the second time this year. One-year deposit rate was slashed by 25 basis points to 3pc. One-year lending rate was set at 6pc. – down by 31 basis points. Just in the previous month, PBoC  reduced  the reserve requirement ratio (RRR) – the amount of cash banks must hold as reserves – to 20pc., as compared to the all-time high of 21.5pc. in last Autumn season of 2011. Business Times (Malaysia) quoted a research economist as saying: “We have placed a 60 per cent chance for PBoC to further reduce the one-year lending rate in the third quarter of 2012 while looking at another two to three cuts for the reserve requirement ratios (RRR), each by 50 basis points also in the second half.” The Chinese Government hopes to sustain the full year growth at 7.5pc. as the least level.

Such moves by China should lend some positive impact to the rest of Asia, especially in the aspect of commodity prices, if China can sustain its growth. 

Diminishing growth concerns are eminently in the minds of the Chinese Government. Premier Wen Jiabao has promised decisive measures and expressed great urgency to prevent the economy from slowing down too rapidly.

The New York Times reported in June that record-setting mountains of excess coal had accumulated at the country’s biggest storage areas because power plants were burning less coal in the face of tumbling electricity demand.  “Electricity production and consumption have been considered a tell-tale sign of a wide variety of economic activity. They have been widely viewed by foreign investors and even some Chinese officials as the gold standard for measuring what is really happening in the country’s economy because the gathering and reporting of data in China is not considered as reliable as it is in many countries.” A senior analyst said coal stockpile at Qinhuangdao Port reached 9.5 million tons in June “as coal arrives on trains faster than needed by power plants in Southern China.” The next three largest coal storage areas, in Tianjin, Caofeidian and Liangyunggang, are also at record levels.

Much news about the Chinese currency Renminbi , or the yuan as it is commonly called, have also emerged now and then in the last 3 - 4 years. China is taking a bigger step to make the yuan a rival to the American Dollar. TIME BUSINESS reported on July 2: “On Friday, Chinese policymakers formally revealed that they would turn a slice of Shenzhen into a new sort of SEZ (special economic zone) to experiment in currency convertibility.” The report said the intention was clear: to free up the ways in which the yuan can be used in international finance. “The country’s policy is to gradually open up its capital account and realize the full convertibility of the yuan,” said Zhang Xiaoqiang, Vice Chairman of National Development and Reform Commission. As it is now, the yuan is already being used more frequently in trade between China and is trading partners via currency swap arrangements. The share of its international trade settled in the yuan constituted 8pc. in 2011. The same report quoted Jun Ma, Deutsche Bank’s chief economist for Greater China, stating “it is apparent that more and more central banks are realizing…………the RMB is the most likely currency to challenge the near monopoly position of the USD in the global reserve system.” To achieve this objective, the policymakers must first be willing to free control over the value of the currency, remove capital controls and implement an open capital account. It will be interesting to observe the trends in the coming years regarding the status of RMB.

INDIA: Growth in the first quarter at 5.3pc. was the lowest in nine years. Inflation rate escalated from 5.3pc in January to 10.2pc.in May this year. Would it be trending back up to around 14pc. as in May 2010?

JAPAN: The former No. 2 world economy (now No. 3 after China took over two years ago) stands the risk of running out of money by the end of October because of a standoff in Parliament that blocked a bill to finance deficit, reported Reuters on July 7. The bill is to allow the government to sell bonds needed to fund almost half of the budget. The impasse, if not resolved with opposition parties by Prime Minister Yoshihiko Noda, will definitely result in jeopardy.

ASEAN:  Probably deemed as good grounds for investment at current times, the Association of South East Asian Nations (ASEAN) predicted to score an overall growth of 5pc. this year. The breakdown of expected growth by ASEAN Economic Report: Thailand (4.9); Malaysia (4.8); Myammar/Burma (5.8); Brunei (2.1); Cambodia (6.3); Indonesia (6.3); Laos (6.8); Philippines (4.1); Singapore (3); Vietnam (5.3). Growth in 2013 is expected to be 6.2pc. Foreign funds continue to pour in.

ON EMERGING MARKETS OVERALL:

Credit Suisse says EM’s GDP growth touched around 5pc.in the first quarter and expects the rate to slow down to 4.5pc. in the second quarter before picking up again in the second half of 2012. On the full year basis, expansion could reach 5.1pc. Next year, the overall rate is projected at 5.6pc. 

So, the near future of the intertwined global economy much depends on the new fiscal measures of the big economic players, i.e. how effective and how soon can these measures not just alleviate the current hogging and bogging issues, but also elevate the situations to higher relief levels. If any of the big “boys” go bust, needless to say the other boys – whether big or small - in the extended economic household will be negatively impacted, especially export-oriented countries. Prudence calls on some nations to commence embarking on side-line mitigating actions while hoping for a reinvigorated global happening; for example, shifting some focus to develop higher domestic demand and consumption as one of the bases for sustaining growth instead of over-relying on export demand - such may be the right move. However, such can only mitigate, and not absolve, the total impact emanating from any untoward upheaval should it occur either in the US, Europe or Asia at large.

I hope you have a better overview grasp of the global economic scenario.

(Before I sign off, I want to thank Chan Cheh Sing and Peter Chiang, my two pals in the asset management career, for having contributed some valuable materials to me.)

Best Regards.

CAVEAT: The contents of this write-up are based on points extracted from various sources in my research. Please note I am not in the position to ascertain the veracity of the entire facts. Therefore, it is your call to counter-check with your own sources or research for further confirmation.