The other D-word

Is Japan back in a deflationary trap?

WHILE investors have been fretting recently about Japan’s huge debt, another of the dreaded D-words has come back to haunt them. On Friday November 20th, Japan’s Cabinet Office issued a monthly report that for the first time since 2006 acknowledged that the country was suffering from deflation.

Consumer prices have actually been falling for months, but the pace of decline accelerated over the summer. In September prices slumped by 2.2% compared with a year earlier. This is partly because the country is still loaded with excess capacity after the collapse in exports during the global financial crisis, and partly because oil prices were lower in September than in the same month last year. But there are more structural problems, too. As Japan’s population declines, for instance, retailers are being forced to cut prices to gain market share.
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Brazil takes off

Now the risk for Latin America’s big success story is hubris

WHEN, back in 2003, economists at Goldman Sachs bracketed Brazil with Russia, India and China as the economies that would come to dominate the world, there was much sniping about the B in the BRIC acronym. Brazil? A country with a growth rate as skimpy as its swimsuits, prey to any financial crisis that was around, a place of chronic political instability, whose infinite capacity to squander its obvious potential was as legendary as its talent for football and carnivals, did not seem to belong with those emerging titans.

Now that scepticism looks misplaced. China may be leading the world economy out of recession but Brazil is also on a roll. It did not avoid the downturn, but was among the last in and the first out. Its economy is growing again at an annualised rate of 5%. It should pick up more speed over the next few years as big new deep-sea oilfields come on stream, and as Asian countries still hunger for food and minerals from Brazil’s vast and bountiful land. Forecasts vary, but sometime in the decade after 2014—rather sooner than Goldman Sachs envisaged—Brazil is likely to become the world’s fifth-largest economy, overtaking Britain and France. By 2025 São Paulo will be its fifth-wealthiest city, according to PwC, a consultancy.

And, in some ways, Brazil outclasses the other BRICs. Unlike China, it is a democracy. Unlike India, it has no insurgents, no ethnic and religious conflicts nor hostile neighbours. Unlike Russia, it exports more than oil and arms, and treats foreign investors with respect. Under the presidency of Luiz Inácio Lula da Silva, a former trade-union leader born in poverty, its government has moved to reduce the searing inequalities that have long disfigured it. Indeed, when it comes to smart social policy and boosting consumption at home, the developing world has much more to learn from Brazil than from China. In short, Brazil suddenly seems to have made an entrance onto the world stage. Its arrival was symbolically marked last month by the award of the 2016 Olympics to Rio de Janeiro; two years earlier, Brazil will host football’s World Cup.
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Breaking up

A dramatic restructuring for ING. Which big European bank is next?

IF ICELAND is the place that has suffered most from the banking crisis, the Benelux countries can make a justifiable claim to second place. After the calamitous sale of ABN AMRO and the subsequent dismemberment of Fortis, ING, the biggest bank in the Netherlands, announced on Monday October 26th that it was splitting itself up. The bank will sell its insurance businesses, divest the American arm of its ING Direct online-banking unit and carve out some bits of its Dutch retail activities. By the time the restructuring is done, in 2013, the bank’s balance sheet will be 45% smaller than it was in September 2008.

That isn’t all. The bank also announced plans for a €7.5 billion ($11.2 billion) rights issue to help repay half the money that the Dutch government injected into ING in October last year. Investors reacted with dismay to the prospect of dilution and the uncertainty of the planned restructuring, sending the bank’s shares down sharply on Monday.

Other equity investors were spooked, too, as they digested the wider implications of the announcement. For shareholders in other banks that have received state aid, the biggest concerns surrounded the European Commission’s role in ING’s break-up. The Dutch bank has its own reasons to act. The rights issue can largely be explained by ING’s desire to start escaping government investment. The break-up is consistent with a “back to basics” plan announced in April by Jan Hommen, ING’s chief executive, that promised to simplify and shrink the institution. Splitting banking and insurance should rid ING of a conglomerate discount. Its shares have historically traded at a 30% discount to bank and insurance indices.
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Down with the dollar

Why the dollar is falling

ON MARCH 5th an index of the value of the American dollar against six other big currencies touched 89.11, its highest point this year. Since then, however, it has been a steady downward drift for the greenback. On Tuesday October 20th, for example, the dollar index had slipped to 75.24, its lowest point in more than a year.

This hardly constitutes an outright collapse, nor is it necessarily cause for concern. American exporters, whose goods have become more competitive abroad, are happy with their weaker currency. Similarly domestic producers may be cheered that rival, imported goods are more expensive. And European tourists, who can buy more for their euros during weekend shopping excursions to America, may cheer too. However, the continued decline of the dollar does come against a backdrop of ominous murmurs from the likes of China and Russia, who hold much of their reserves in dollars, about the need to shift their reserves out of the greenback.

Worries about the dollar are hardly new. Well before the credit crunch some fretted that a collapse in the currency and a jump in Treasury-bond yields, as foreigners balked at funding America’s current-account deficit, would precipitate an economic crisis. Instead sub-prime mortgages and over-leveraged financial institutions plunged the world into its worst recession since the Great Depresssion.

The recession, which reduced America’s imports as consumers tightened their belts, has improved its trade imbalance, shrinking its current-account deficit. But ironically this has been accompanied by renewed weakness for the dollar.
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Slim pickings, no appetite

Constrained lenders and wary borrowers explain falling levels of credit in America

THE worst may be over for America’s financial markets, but they are still abnormal. Bill Dudley, head of the Federal Reserve Bank of New York, captured the mood in a recent speech, bluntly titled “A bit better, but very far from best”. In a survey released this week, members of the National Association of Business Economics said markets would continue to drag on economic growth until at least mid-2010.

For many the big question is whether a lack of credit is holding back America’s nascent recovery. In a sign of easing conditions, usage of the Fed’s special liquidity facilities has fallen markedly and the central bank is gradually winding down its asset purchases. Securitisation markets are thawing, with volumes approaching pre-crisis levels in credit-card debt and car loans—though not in mortgages, which remain dependent on government support.

But at the same time the overall level of credit is dropping. Bank lending expanded in the thick of the crisis as companies tapped pre-agreed credit lines. But it has since fallen back sharply, from $7.14 trillion in May to $6.78 trillion in September, with the decline accelerating recently. Is this down to a reluctance to lend, or to borrow?
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Dow Jones breaks through 10,000

The Dow Jones Industrial Average has topped the 10,000 mark for the first time in a year.

World markets were boosted by the news that US bank JP Morgan Chase reported a better-than-expected profit in the July-to-September quarter.

The Dow closed up 144.8 at 10,015.86, its highest since October 2008.

But correspondents say the Dow is still far off its all time highs and the US economy has a long way to go before there is real recovery.

Earlier, European markets had also closed higher, with banking stocks leading the way up.

‘Largely psychological’

The BBC’s Michelle Fleury in New York says that a year ago major banks were struggling under the weight of huge credit losses and the US administration was doing its best to avoid an all out collapse of the financial system.
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The long climb

The world economy is recovering from financial disaster. But it will not return to normal as we know it, says Simon Cox

NEWPORT BEACH, California, is not a bad place to contemplate the future of the world economy. Its information office promises nine miles of pristine sand, fine dining for devoted epicureans and an atmosphere of laid-back sophistication. Yet students of economic turmoil will find their subject matter conveniently close to hand. California’s unemployment rate has doubled to 12.2% since the start of 2008. Saddled with the worst credit rating in the country, the “Golden State” is cutting spending on schools, prisons and health care for the elderly, as well as closing parks and laying off staff for three days a month. It will pay its workers a day late at the end of the fiscal year so that the expense will show up in next year’s budget. Financial shenanigans are not the sole province of the banking industry.

Newport Beach is also the home of Pimco, the biggest bond manager in the world, which handles $840 billion on behalf of pension funds, universities and other clients. In May the company held its annual “Secular Forum”, in which it tries to peer five years into the economic future. After two days of rumination, Pimco’s laid-back sophisticates concluded that the financial markets may well “revert to mean”, which is a statistician’s way of saying that what comes down must go up. But the next five years will not resemble the five preceding the crisis. Not every change wrought by the financial breakdown will be reversed. The world economy is fitfully getting back to normal, but it will be a “new normal”.
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Russia economy ‘to shrink 7.5%’

Russia’s economy will shrink by 7.5% in 2009, President Dmitry Medvedev has said – but claimed Kremlin intervention had prevented a worse decline.

Russia, which is heavily reliant on oil exports, has been hit by the sharp fall in energy prices.

Mr Medvedev said the decline was “very serious” and admitted the government had been surprised at how severely Russia had been hit by the crisis.

However the predicted slide in GDP was less than earlier predictions.

“The real damage to our economy was far greater than anything predicted by ourselves, the World Bank and other expert organisations,” Mr Medvedev told Russian television.

But he said that measures to save jobs and stabilise the country’s banking sector had paid off.
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After the storm

The new economic landscape will be grim unless policymakers act to foster growth

IN THE political dictionary he first published in 1968, William Safire, who died on September 27th, devoted an entry to the word “normalcy”. The term was made popular by Warren Harding, campaigning for America’s presidency in the wake of the first world war. It was inescapable after the terrorist attacks of September 11th 2001. Normalcy is what people call normality when they no longer take it for granted. No surprise, then, that the word reappeared in the communiqué released by the leaders of the G20 group of big economies after their Pittsburgh summit on September 24th-25th. After the wrenching economic crisis of the past year, people crave stability and predictability—in short, normalcy. But how far off is it? And what will a “normal” world economy look like after the biggest financial bust since the Depression?

The new normal

Glance at share prices or short-term growth forecasts and you might feel comforted. Output has stopped shrinking in all the world’s big economies. In its latest forecasts the IMF reckons global GDP will expand by 3.1% next year, 1.2 percentage points faster than it forecast in April. Global stockmarkets have rallied by 64% since their trough. Corporate finance, once frozen, is thawing fast. Bearish analysts are once again having to justify their pessimism.
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Coming back down under

Australia is the first large, rich country to raise interest rates in more than a year

AUSTRALIA’S central bank is the first in a big, rich economy to raise interest rates since July last year. On Tuesday October 6th the overnight “cash rate” was raised by a quarter of a percentage point, to 3.25%. Glenn Stevens, the bank’s governor, explained that economic conditions in Australia have been stronger than expected and measures of confidence have recovered and that “forecasts are being revised higher…and growth in 2010 is likely to be close to trend.”

Is this the beginning of a general shift in monetary policy as central bankers around the world begin to prepare for economic recovery? In fact Australia is a special case. Interest rates remain four percentage points below their recent peak in March 2008 and local markets had been expecting a rate rise before the end of the year. The big Australian banks anticipated the central bank’s move, and have been increasing their fixed lending rates throughout the year. More rises are expected, especially as Mr Stevens has concluded that the risk of serious economic contraction in Australia has passed. Annual inflation is 1.5%, but it is 2.5% when volatile items are excluded. It seems set to go higher.
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