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1 THINGS THAT MAKE YOU GO Hmmm A walk around the fringes of finance O, swear not by the moon, the fickle moon, the inconstant moon, that monthly changes in her circle orb, Lest that thy love prove likewise variable. WILLIAM SHAKESPEARE Doyle Lonnegan: Johnny Hooker: The Sting Your boss is quite a card player, Mr. Kelly; how does he do it? He cheats. In today s regulatory environment, it s virtually impossible to violate rules... but it s impossible for a violation to go undetected, certainly not for a considerable period of time Bernard Madoff 28 March

2 2. On May 12th 1849, Thomas McDonald was walking along William Street in New York City when he was hailed by a man of genteel appearance who proceeded to strike up a conversation with him. After a brief exchange between the two the friendly stranger turned to McDonald and asked matter-of-factly have you confidence in me to trust me with your watch until tomorrow? Despite being unable to place the stranger, the familiarity of the simple request was such that McDonald presumed the man to be an old acquaintance not recollected and happily handed over his $110 pocket watch. The dapper stranger strolled off in good spirits, never to be seen again - but for a strange quirk of fate. On July 7th of the same year, McDonald was walking along Liberty Street (sans timepiece) when he happened upon the stranger once again. Recognizing him as the same man who had relieved him of his watch weeks earlier, McDonald hailed Officer Swayse of the Third Ward who just happened to be nearby and, after a short chase and an even shorter struggle, the man had his hands bound and was marched to the nearest police station. Upon having the thief brought before him, Justice McGrath recognized the felon as one William Thompson, an old offender and graduate of the college of Sing Sing and remanded him to prison for further hearing. It transpired that Thompson had been wandering the streets of New York City for several months and using the same method to relieve trusting strangers of a significant number of valuable watches. In that time, he had become known to the constabulary as well as a headline-hungry press as The Confidence Man. William Thompson, while by no means the world s first trickster, but he happened to time his escapades with the rise of the print media and so, consequently, with the New York Herald looking to sell more newspapers, both a nickname and an anti-hero were born. Through the years, the term Confidence Trick has been shortened to con (also known as a bunko, flim-flam, gaffle, grift, hustle, scam, scheme, swindle or bamboozle) and has become a catch-all for any ruse designed to dupe someone into believing something that isn t true in order to relieve them of something of value. Very rarely, when hearing the word con these days, do we immediately associate it with the longer word from which it originates. A con has immediate connotations of the negative kind (the most high-profile in recent memory perhaps being that perpetrated by inmate of Butner Prison, North Carolina: a Mr. Bernard Lawrence Madoff), whereas the word from which it derives is generally used to convey a sense of the positive. And yet... Every month, all around the world, financial mavens scrutinize the collective confidence as a means to interpret both the mood of the populace and as a predictive tool for the future. The various Consumer Confidence numbers released for economies around the globe are used as a barometer by analysts and investors to try and determine which direction and to what extent markets will move. Will declining confidence affect consumer spending? Will it lead to reduced investment? Just what DOES the prevailing mood of the public at large tell us? Of course, the fact that these figures are distributed monthly allied with the ability of the average 28 March

3 3. human being to change his (or her... I definitely do NOT want to exclude the fairer sex from THIS example) mind many times during an extended period such as that, makes them a somewhat unreliable indicator - or at least, one subject to sudden reversals based upon external factors. This past week, we have seen the release of a number of confidence figures throughout the world and a perusal of those numbers makes for an interesting exercise: First up, the United States: (March 25): Consumer sentiment in the U.S. dropped more than forecast in March, damped by higher gasoline costs and the effects of Japan s natural disaster. The Thomson Reuters/University of Michigan final index of consumer sentiment decreased to 67.5, the lowest level since November 2009, from 77.5 in February, the group said today. The median forecast of 67 economists surveyed by Bloomberg News projected a reading of 68. Then to Korea: (March 25): South Korean consumer confidence fell to the lowest level in almost two years, damped by Japan s strongest earthquake and political unrest in the Middle East. Retailers stocks dropped in Seoul trading. The sentiment index declined to 98 in March from 105 in February, the fourth monthly drop... Consumer confidence worsened so sharply, boding ill for private consumption and also economic growth, said Park Sang Hyun, chief economist at HI Investment & Securities Co. in Seoul. If oil prices stay above $100 a barrel for another month, sentiment will deteriorate further, prompting the central bank to pause interest-rate increases next month. How about the UK?: (March 18): U.K. consumer confidence fell to a record low in February as Britons grew more pessimistic about the sustainability of the economic recovery and the outlook for jobs, Nationwide Building Society said. An index of sentiment dropped 10 points to 38, the lowest since records began in A measure of whether now is a good time to spend dropped 18 points to 52, also the lowest since the survey began. A gauge of consumers future expectations fell 14 points to 50 and an index of their view of the present situation slipped 3 points to 20, the lowest in 18 months, the report showed. High inflation has led many to expect interest rate rises by the summer, which may in turn have fanned concerns about mounting pressure on household budgets, Gardner said. He sees rates on hold until the back end of France?: (March 25):French consumer confidence fell to an eight-month low in March as surging energy costs sapped spending power and President Nicolas Sarkozy readied a new wealth tax. An index of sentiment fell to 83 from 85 in February, national statistics office Insee said today in an ed statement. That was the lowest reading since July. With oil prices up more than 40 percent in a year, French motorists are paying more for gasoline while the government is planning electricity-price increases for later this year. That s slashing spending power at a time when joblessness remains stuck near a seven-year high. 28 March

4 4. So it seems fair to say that the average consumer is not necessarily feeling quite as confident about any recovery as governments around the world would like them to. Soothing talk of improvements which will lead to the return of the good times can be heard from Finance Ministers, Prime Ministers, Presidents and Kings across the globe; but why is it so important to watch these confidence figures? Surely, if things ARE, in fact, getting better then the confidence will return organically? With interest rates at all-time lows, housing prices in many places (though definitely NOT here in Singapore) significantly lower (and by extension, affordable) than they were a few short years ago, the unemployment situation stabilizing and the meltdown of the financial system averted by a courageous Band of Brothers, what the hell is everybody so worried about? A look at the University of Michigan Consumer Expectations Index paints another worrying picture as it nosedived last week to levels SOURCE: ZEROHEDGE below those seen when the recession was still uppermost in people s minds back in the dark days of The drop was the 5th largest on record. As a sidebar, it s interesting to note that the first month after the recession officially began back in 2008 saw a positive jump in expectations, while the first month after its end saw the opposite reaction. Fickle things, humans. Now, it seems quite reasonable to assume that, ultimately, at its base, this is all about confidence. If people are confident about their own prospects as well as those of the economy as a whole, they will be happier to spend their money. If they spend that money then other people will make more stuff for them to spend it on which, in turn will put more money in the pockets of those making that stuff who will then go out and buy stuff of their own. Everybody ends up with a lot of stuff which makes everybody happy. Stuff equals happiness. There. Economics for Dummies. At this point in the proceedings, a quick trip back to the aftermath of 9/11 and an article in the National Post (Canada) proves quite educational: (September 28, 2001): Western leaders, worried about the possibility of a recession fuelled by terrorist attacks in the United States, are urging their citizens to spend money, take vacations and buy new cars and homes. Jean Chrétien, George Bush and Tony Blair yesterday all called on consumers not to be spooked by the cataclysmic attacks of Sept. 11. Mr. Bush urged Americans to get on the airlines, get about the business of America as he announced improved security measures on commercial flights. 28 March

5 5. CLICK FOR SLIDESHOW Mr. Blair used a news conference at 10 Downing St. to appeal to the British public to return to everyday life, including their usual spending habits, to fend off recession. People in this country ask what should they do at a time like this, Mr. Blair said. The answer is that they should go about their daily lives: to work, to live, to travel and to shop -- to do things in the same way as they did before Sept. 11. And Mr. Chrétien urged Canadians to face down terrorists with their wallets... Mr. Chrétien observed that interest rates have been cut to the lowest level in years, so it is time to go out and get a mortgage, to buy a home, to buy a car. Some American officials are even calling a trip to the mall an act of patriotism as the United States tries to rebound and rebuild. Rudolph Giuliani, the Mayor of New York, has said that his battered city needs the best shoppers in the world to return to restaurants, Broadway shows and shops. And local officials in Florida have declared this weekend Freedom Weekend, a time for people to do their patriotic duty and spend money. Go out and contribute to the economy, Alex Penelas, the Miami-Dade County Mayor, said at a news conference yesterday. As my wife said, it has never been more patriotic to go shopping. The problem comes when, despite plenty of talk about things getting better from those elected to make us all happy, despite us being told that disaster has been averted, that unemployment lines are getting shorter and that things are definitely on the up, confidence wanes and people just stop believing. When that happens, the trouble begins. Just yesterday, London saw the biggest union-organized protest in 20 years as over 250,000 peaceful protesters marched from Westminster to Hyde Park to demonstrate AGAINST austerity measures being enacted by the coalition British government. The march was, perhaps predictably, hijacked by youthful anarchists who had clearly decided either that Top Shop was the number one villain in the corporate world, or this was a tremendous excuse to don a hood and a bandana and have a day out in London smashing things up - I know what I think to be the truth of the matter. SOURCE: UK DAILY TELEGRAPH But I digress. The pictures of violence and confrontation will no doubt garner the headlines around the world, but to me, this picture (left) is far more illustrative of the problems facing not just the UK, but the world at large. Here we have 250,000 people, all of whom are seeing their standard of living steadily reduced as first recession, then inflation (yes, inflation - not core inflation but man-in-the-street inflation: Cor! inflation if you will) and now austerity have swept over them in waves. These people want things fixed. They want petrol and food prices lower, unemployment queues shorter, wages higher and, if not Hoover s chicken in every pot then at least a Hoover and some nuggets in every freezer. 28 March

6 6. The problem is - as the placards scream - they want all this with No Cuts. As I have said from the outset of the ongoing efforts to fix the problems facing the world; austerity is a dish best served to somebody else, and we are now seeing that writ large in countries all across the world. Austerity doesn t HAVE to be about cuts in services or public sector wages. It simply means extreme economy and, if that means not being able to afford food then it is just as likely to result in violence and uprisings as slashing public pension benefits or laying off teachers. This unrest and dissatisfaction with the enactment of measures designed to eventually bring back the good times is sweeping the world and is rapidly getting out of control. Governments are being faced with stark choices. Continue down the path of austerity in the knowledge that it is the right thing to do for the electorate, but face up to the fact that you will be ridden out of town on a rail at the first available opportunity, or cave in to such populist anger and turn on the printing presses once again. Until now, the second of those options has been far and away the popular political choice, but with the soaring cost of staples - a direct cause of this monetary largesse no matter what ANYBODY tries to tell you - starting to bite, the options - as well as the time - are running out fast. In any confidence trick, there are two parties. One is the confidence man or grifter,the other is the mark. according to wikipedia: Confidence men or women exploit characteristics of the human psyche such as greed, both dishonesty and honesty, vanity, compassion, credulity, irresponsibility, naïveté, and the thought of trying to get something of value for nothing or for something far less valuable. Look around you today and you will see an endless stream of politicians, Central Bankers and Heads of State telling us that things are on the mend and that we should be confident about the future. These people are most definitely trying everything they can to appeal to the human psyche. And as we know, there are two parties to every confidence trick... Phew, I ve almost run out of space today - sorry about the rambling introduction - so here is a quick summary of what you ll find in these pages today: A look at Russia - the cheapest market in the world, a man imprisoned in the US for taking out a subprime loan, George Osborne s lack of a Plan B, the strange underground city beneath Beijing, the effect that oversupply is having in the US housing market, the latest thoughts of China s Central Bank on the fate of the dollar, the Euro, commodities and gold, Japan on life-support, China s nuclear expansion (which isn t about to stop any time soon), Timothy Geithner reminds China that they re open for business, Alasdair Macleod looks at the relationship between equities and inflation, charts of nominal house price increases, stockmarket bounces, Chinese growth and gold holdings, a little Glenn Back madness, some Gerald Celente a look at public buying of gold in China and finally, Charlie Brooker takes the press apart as only an Englishman could. There. Couldn t have fitted in another word. 28 March

7 7. Contents 28 March 2011 What s Driving Russia s Outperformance? Ireland, Portugal Britain? George Osborne only has Plan A In Prison for Taking a Liar Loan Underground World Hints At China s Coming Crisis A Housing Market Cycle Different From Others China Sees Strong Commodities, Weak Dollar In 2011 We re Just Gonna Inflate Our Way Out Of It! China Punches Pause Button for Nuclear Power Geithner to China: We re Open for Investment Inflation And Equities Charts That Make You Go Hmmm... Words That Make You Go Hmmm... And Finally March

8 8. The Russian MICEX Index, which increased 22.5 percent in 2010, has jumped 15 percent so far in 2011, significantly outperforming many other markets... This has effectively recoupled Russia with the other BRIC countries. The Russian economy lagged out-of-the-gate once the global recovery began, leading some to question whether it belonged in the same category as Brazil, China and India. Those sentiments seemed premature and symptomatic of an anti-russia mindset. Russian s outperformance has been driven by several factors. First, the Russian ruble has appreciated 7 percent against the U.S. dollar, boosting stock market performance for U.S. investors. This development also has a long-term benefit as a strong ruble benefits the country s domestic sectors, something we ll discuss later. A second factor driving Russia has been the geopolitical and natural disaster events that have transpired during the past few weeks. Russia is relatively safe from the type of political uprisings seen in the Middle East and North Africa. Its government is decidedly popular with the public and the one-two punch of President Medvedev and Prime Minister Putin give the government clout on both international and domestic fronts. The price of oil has risen roughly 25 percent since the unrest and turmoil began in the Middle East and North Africa. As an energy exporter of crude oil and natural gas, Russia is one of the few large economies in the world that directly benefits from higher energy prices. Russia is the world s largest oil producer and it s estimated that for every $10 increase in the average annual price of oil, Russia s revenues rise by $20 billion, according to the Financial Times. Since Russia is not a member of OPEC, it is not bound by production caps and can increase production as it sees fit while prices are at elevated levels. SOURCE: DATASTREAM/MSCI Russia is also the world s top exporter of natural gas and Stratfor Intelligence points out the situation in Libya has shut down 11 billion cubic-meters of natural gas flow to Italy. As Europe s third-largest consumer of natural gas, Italy has turned to Russia for gas supplies. In addition, a shutdown of several Japanese nuclear facilities could mean as much as a 14 percent increase in natural gas consumption to meet the Japan s energy demands. OOO USFUNDS / LINK Portugal loses a government and sees bond yields soar. Ireland announces a third straight year of economic contraction. Britain suffers a slump in high street spending as consumers get cold feet. The ratings agency Moody s says the UK s coveted AAA rating could be at risk if the weakness of the economy derails plans to put the public finances in good order. A leading Bank of England policymaker says rising inflation is putting the Old Lady s credibility at risk. As far as George Osborne is concerned, making sense of this welter of post-budget news is simple. 28 March

9 9. The lesson for Britain is that the only way to avoid becoming the next Portugal or Ireland is to stick to Plan A, the four-year deficit reduction programme that will run for the rest of the parliament. Yes, it will be tough. Yes, there will be occasional setbacks, but the only way to keep Moody s, S&P and Fitch sweet is to stay the course. The chancellor remains confident that growth will gradually pick up during the course of the year and be better balanced than it has been in the past. That said, the news from Ireland, the warning from Moody s and February s sharp fall in retail sales do highlight the risks for the government. Like the UK, Ireland used to be the poster child for the deficit hawks at the Organisation for Economic Co-operation and Development and the International Monetary Fund, who ladled praise on Dublin for their courage in cutting the budget deficit. Today, Ireland provides evidence of the deflationary pit that a country can dig itself into if it cuts too hard too fast. In the UK, the assumption is that the economy can withstand the medicine Osborne has in store for it, but the 0.8% drop in spending last month was evidence of the weakness of consumer confidence following the slowdown in the economy in the second half of 2010 and the jump in VAT at the start of the year. It added to doubts among economists about the ability of Britain to meet the growth forecasts made for the chancellor by the independent Office for Budget Responsibility. In the past, Britain (along with other countries) has bounced back rapidly from recessions, but not this time. At 1.3% in 2010 and a projected 1.7% in 2011, the UK is, at best, on course for an extremely sluggish recovery. The risks to these forecasts are to the downside, because high inflation is squeezing real incomes, public sector workers are being laid off and next week sees taxes increased and benefits cut. There will be some pick-up in growth in the first quarter of 2011 following the weather-affected 0.6% drop in the final three months of 2010, but the portents are not good for the second and third quarters of 2011, particularly if the Bank does start raising interest rates in May as the City expects. OOO THE UK GUARDIAN / LINK A few weeks ago, when the Justice Department decided not to prosecute Angelo Mozilo, the former chief executive of Countrywide, I wrote a column lamenting the fact that none of the big fish were likely to go to prison for their roles in the financial crisis. Soon after that column ran, I received an from a man named Richard Engle, who informed me that I was wrong. There was, in fact, someone behind bars for what he d supposedly done during the subprime bubble. It was his 48-year-old son, Charlie. On Valentine s Day, the elder Mr. Engle said, his son had entered a minimum-security prison in Beaver, W.Va., to begin serving a 21-month sentence for mortgage fraud. He then proceeded to tell me the tale of how federal agents nabbed his son a tale he backed up with reams of documents and records that suggest, if nothing else, that when the federal government is truly motivated, there is no mountain it won t move to prosecute someone it wants to nail. And it was definitely motivated to nail Charlie Engle. Mr. Engle s is a tale worth telling for a number of reasons, not the least of which is its punch line. Was Mr. Engle convicted of running a crooked subprime company? Was he a mortgage broker who trafficked in predatory loans? A Wall Street huckster who sold toxic assets? No. Charlie Engle wasn t a seller of bad mortgages. He was a borrower. And the mortgage fraud for which he was prosecuted was something that literally millions of Americans did during the subprime bubble. Supposedly, he lied on two liar loans. 28 March

10 10. The Department of Justice has made prosecuting financial crimes, including mortgage fraud, a high priority, said Neil H. MacBride, the United States attorney for the Eastern District of Virginia, in a statement. (Mr. MacBride, whose office prosecuted Mr. Engle, declined to be interviewed.) Apparently, though, it s only a high priority if the target is a borrower. Mr. Mozilo s company made billions in profit, some of it on liar loans that he acknowledged at the time were likely to be fraudulent and which did untold damage to the economy. And he personally was paid hundreds of millions of dollars. Though he agreed last year to a $67.5 million fine to settle fraud charges brought by the Securities and Exchange Commission, it was a small fraction of what he earned. Otherwise, he walked. Thus does the Justice Department display its priorities in the aftermath of the crisis. OOO NYT / the city s vast network of unused air defence bunkers, as many as a million people live in small, windowless rooms that rent for 30 to 50 a month To understand how far ordinary Chinese have been priced out of their country s property market, you need to look not upwards at the Beijing s shimmering high-rise skyline, but down, far below the bustling streets where nearly 20m people live and work. There, in the city s vast network of unused air defence bunkers, as many as a million people live in small, windowless rooms that rent for 30 to 50 a month, which is as much as many of the city s army of migrant labourers can afford. In a Beijing suburb, beneath one of the thousands of faceless residential tower blocks that have carpeted the city s peripheries in a decade-long building frenzy, one of Beijing s bomb shelter hoteliers, as they are known, agrees to show us his wares. Passing under a green sign proclaiming Air Defence Basement, Mr Zhao leads us down two flights of stairs to the network of corridors and rooms that were designed to offer sanctuary in the event of war or disaster. We have two sizes of room, he says, stepping past heaps of clutter belonging to residents, most of whom work in the nearby cloth wholesale market. The small ones [6ft by 9ft] are 300 yuan [ 30] the big ones [15ft by 6ft] are 500 yuan. Beijing is estimated to have 30 square miles of tunnels and basements, some constructed after the Sino-Soviet split of 1969, when Mao s China feared a Soviet missile strike, and many more constructed since to act as more modern emergency refuges. The fact Mr Zhao can easily rent out 150 such rooms, with the connivance of the city s Civil Defence Bureau with whom he has signed a five-year contract and invested nearly 150,000, is testament to China s massive unfulfilled demand for affordable housing. Some 80pc of our tenants are girls working in the wholesale market and the rest are peddlers selling vegetables or running sidewalk snack booths, he adds. There are dozens of similar air defence basement projects in residential communities. In this area, they say 100,000 live underground. Checking out the price of property above ground it is not difficult to see why. To buy a small flat (860 sq ft) in the tower block above a typically grim, grey concrete affair currently costs more than 200,000. In a city where the average monthly salary is 4,000 yuan, the average person would take 50 years to buy such an apartment, assuming they saved every penny they earned. OOO UK DAILY TELEGRAPH / LINK 28 March

11 11. CLICK TO ENLARGE SOURCE: NYT To judge by the overall level of home sales in the United States, the housing market has stabilized at a level well below the peak period of 2005 and 2006 but still higher than the sales rates that characterized prosperous periods in the 1980s and 1990s. Still, few of those sales are of new homes and a rising proportion are forced sales of homes no longer worth the amount that was borrowed. As can be seen in the accompanying chart, during the 12 months through February, about 46 homes were sold for every 1,000 households in the country. At the peak of the housing boom, that figure rose above 75, but the current level is significantly higher than the lows reached during the recessions of the early 1980s and early 1990s. The sales rate for existing homes about 4.9 million over the last 12 months is virtually the same as in mid Yet sales of newly built single-family homes have plunged to the lowest levels seen since the government began collecting statistics on such sales in The Census Bureau reported this week that only 17,000 new homes were sold in February, for an annual rate of 250,000 after taking seasonal factors into account. Both of those numbers are the lowest on record. The February sales pace was undoubtedly depressed by harsh weather in the Northeast, and a rebound in March or April is possible. But the total number of homes sold over the 12-month period 349,000 is lower than in any comparable period. As a result, this cycle has been very different from previous ones. Home sales plunged in the early 1980s, when a combination of severe recession and high interest rates devastated the housing business, and they also suffered in 1990 and 1991, another recessionary period. But in each of those recessions, sales of new and existing homes declined at about the same pace. It was decreased demand that hurt sales in previous downturns. Now demand is down, in part because some would-be buyers cannot qualify for mortgages that would have been available during the boom. But oversupply is also a major problem now. OOO FLOYD NORRIS / LINK Loose monetary policies in developed economies will place more upward pressure on global commodity prices and weigh on the dollar this year, the Chinese central bank said on Friday. In a report reviewing the performance of global financial markets, the People s Bank of China also warned of a deepening of the European debt crisis, though its broad view was colored with optimism. We expect that the world economy will keep recovering, and the foundation for the recovery will be firmer, it said in the 125-page report. In a brief discussion of risks, it pointed to Europe s debt woes as well as inflation and the potential for asset bubbles in developing markets. 28 March

12 12. We need to note that gold prices have reached historical highs, and its downward risks should not be overlooked, the central bank said. On balance, however, it said that the dollar would fare worse than the euro. In 2011, the dollar will be on a downward trend overall, because of the slow recovery of its economy, low interest rates and twin deficits, the central bank said. The possible spreading of European sovereign debt crisis and geopolitical risks may push up the dollar in some periods. It noted that short-term interest rates in major economies would gradually rise as their recovery solidifies. But as the global recovery momentum is not strong, the increases will not be too large, it said. Looking at global commodities, it said that wealthy nations were printing money to kickstart their economies and this would inevitable push up prices. Developed countries will continue with their loose policies and global liquidity will remain ample, which will keep prices of commodities, especially crude oil and grains at high levels, it said. Concerns about inflation would trigger demand for gold as a store of value, but the precious metal s bull run may be near its end, it added. We need to note that gold prices have reached historical highs, and its downward risks should not be overlooked, the central bank said. OOO REUTERS / LINK At this point, meaningfully rising rates in Japan would cause a rise in debt service payments that would crash directly into the current level of offsetting revenue collection by the government and leave little else in the way of excess funds in its aftermath We re Just Gonna Inflate Our Way Out If It!...Oh really? I don t think so, Scooter. In a recent discussion we mentioned the fact that lately former Fed member Larry Lindsey has been talking up the idea of a potential fiscal trap for the US. To be honest, we believe this idea has already played itself out in Japan and day by day is coming to a Euro theater near you in terms of individual country experience. The whole idea of a fiscal trap involves the combination of sovereign debt levels with manipulated domestic interest rate levels. Japan has been a poster child example of this simple concept. By artificially holding its domestic interest rates at the theoretical zero bound, it has allowed the government to lever up in a magnitude that most likely never could have happened had free market forces set domestic interest rate levels. Japan has enjoyed an artificial depressant on nominal dollar (in this case Yen) interest costs that has made incredible sovereign debt expansion feel relatively benign from an ongoing debt servicing cost perspective relative to what has been up to this point the magnitude of ongoing sovereign revenue collection. Many moons ago we were involved with an investment idea for a time that was essentially a rollup of and specialized focus upon ventilator hospitals. The company was called Vencor. As a result of that investment we necessarily needed to get up to speed on the medical profession subspecialty that is pulmonology. And what struck us at the time as being so critical in many patient cases was the weaning period or window of opportunity so necessary for a patient to get off a ventilator. In the majority of cases involving a shorter term illness, the weaning period was simply a natural part of total patient recovery. But as you would imagine in a smaller number of cases, patients were not so fortunate. Although this is a very generic comment and completely dismisses patient and circumstance individuality, the fact is that the longer a patient remained on a ventilator, the greater the chances they would not be able to be weaned 28 March

13 13. off of the machine. The body learns not to breathe on its own after a period of time. Essentially a patient would pass a critical window of recovery weaning period opportunity. So, first, our personal apologies as we know this analogy is neither light hearted nor fun to discuss. Somber may be the true characterization. But we believe this analogy is incredibly apt in terms of describing the reality of the sovereign debt fiscal trap. The longer Japan has been on the artificial zero interest rate breathing machine over the last decade plus, the harder it has become to wean itself off. Although we could spend an entire discussion on Japan alone, we personally believe Japan has already passed the critical weaning period demarcation line for zero bound interest rate/monetary policy. At this point, meaningfully rising rates in Japan would cause a rise in debt service payments that would crash directly into the current level of offsetting revenue collection by the government and leave little else in the way of excess funds in its aftermath. Of course after so many years of zero bound for Japan, investors seem to believe rates will remain near zero indefinitely. This is what complacency is all about. Although this sure seems to be the real world reality that hovers over Japan, the Japanese fixed income markets have clearly not priced this in as of yet. Somewhere down the road it appears an inevitability. Again, a very big story that will be told another day. But when that day comes, it may indeed be quite the eye opener and repricing event for sovereign debt globally. OOO CONTRARY INVESTOR / LINK...most industry experts say China is unlikely to change its pro-nuclear direction. Japan s earthquake-related nuclear catastrophe chilled, yet by no means froze, China s fast-advancing nuclear energy industry by forcing a closer look at the nation s reactors and safety issues. Five days after the deadly quake March 11, an executive meeting of the State Council chaired by Premier Wen Jiabao ended with an order for a full review of all nuclear power plants currently under construction. Moreover, the council declared, any reviewed project found lax in safety standards would be halted. The State Council also ordered adjustments to the government s 2007 Medium and Long-term Plan for Nuclear Development, and said approval permits for new projects, including those at a preliminary start-up stage, would be suspended pending a development plan update. Share prices for nuclear energy-related companies fell sharply on the Shanghai and Shenzhen exchanges the day after the State Council s announcements. Prices for three stocks fell to the daily limit, while many others lost at least 6 percent of value. Yet despite government review orders and stock sell-offs, most industry experts say China is unlikely to change its pro-nuclear direction. The disaster in Japan will have a tremendous impact on domestic nuclear power, they say, but the industry will survive. More than 77 nuclear power generating units were either planned or under construction in China at the end of 2010, according to the World Nuclear Association. In addition, various local governments around the country have said they intend to build as many as 140 additional units. Thirteen nuclear power units at six sites are now operating in China. Construction has gotten under way for 29 plants since 2007, with 14 projects project launches in 2008 alone. The combined number of units operating, under construction and planned in China 90 as of January nearly equals half the number of nuclear plants currently on-line worldwide. OOO CAIXIN / LINK 28 March

14 14. America is open for Chinese investment and a key government foreign investment review agency focuses solely on national security concerns, U.S. Treasury Secretary Timothy Geithner said. The longstanding U.S. commitment to welcoming investment from abroad extends to investment from China, Geithner told Caixin in an exclusive interview March 22 in Washington. The U.S. is one of the most open economies in the world for foreign investment, and has been for many years. Geithner s comments came a day after Chinese Premier Wen Jiabao called on the United States to further open its market and ease restrictions on high-tech exports to China. A number of high-profile Chinese investment proposals have hit the wall in the United States since For example, telecom equipment giant Huawei Technology has had to abort several deals. The Chinese company withdrew a scheduled acquisition of U.S.-based 3Com in 2008, saw a bid for 2Wire whither, and last year failed to acquire Motorola s wireless-equipment branch. In February, following suggestions from the U.S. government s Committee on Foreign Investment in the United States (CFIUS), Huawei gave up an attempt to buy technology from a company called 3Leaf. Geithner said CFIUS focuses on genuine national security concerns raised in connection with individual transactions, not broader national or economic interests. CFIUS applies the same rules to investors from every country, including China, he said. Numerous Chinese investments in the United States have passed successfully through the CFIUS process, including foreign government-controlled investment. In a recent paper, the New York-based research firm Rhodium questioned whether the U.S. government is blocking Huawei for reasons specific enough to satisfy U.S. statutory requirements, or whether the objections are too general. Dan Rosen, a Rhodium partner, said political interference in foreign investment decisions is growing in Washington, and not all of the noise is linked to CFIUS decisions. Former administration officials involved in review proceedings, and many of the lawyers currently involved in deliberations, believe there is systematic mistrust of China among CFIUS participants, said Rosen. OOO CAIXIN / LINK There is a general belief that equities offer the best protection from increasing inflation. This over-simplifies the relationship between share prices and inflation and is only true in certain circumstances. Gold and silver mining enterprises however are the true beneficiaries of inflation, but for investors in bog-standard equities there will be substantial losses before the final inflation protection kicks in. The perception of the benefits of inflation to share prices often arises from a comparison to bonds. But on a total return basis, assuming reinvestment of income, the returns are actually not much different. The annual return on the ten-year US Treasury bond over the last forty years was 7.18%. A lump sum invested in this instrument in 1971 with income re-invested would be worth nearly fifteen times 28 March

15 15. as much today, while an investment in the S&P would have grown only thirteen times, to which one must admittedly add re-invested dividends. A greater influence by far is changes in interest rates. Over the credit cycle, interest rates are initially depressed by the central bank to encourage business investment and economic growth. It is at this point that equities are usually in well-established bull markets. The pundits will tell you that equities...interest rates are at record lows and have fuelled share price rises, conforming to the first phase of our credit cycle model. But instead of inflation arising from excess demand, we have stagflation, the result of excess money in circulation. are discounting improving profits; while there is some truth in this the realty is that equity prices are benefiting mostly from the expansion of money and credit and low interest rates. But the longer that interest rates are held artificially low, the greater the expansion of money and credit and the greater the inflationary pressures that result. Eventually interest rates have to be raised, to the detriment of both bond and equity prices. The credit cycle in this simple theoretical example should perhaps be completed by the excesses of money and credit being withdrawn: in other words the mistake of an expansionary monetary policy is realised and corrected. In reality, there is a ratchet effect, because the credit created in the previous cycle is allowed to stand, and the general price level is not permitted to fall. Consequently, the cumulative effects of these credit cycles are reflected in the long-term trend for inflation. Share prices reflect this trend through progressively rising cyclical highs and lows, supporting the contention that equities offer a hedge against inflation, while conveniently overlooking the bear markets at the end of each credit cycle. The situation today is radically different in an important respect. Interest rates are at record lows and have fuelled share price rises, conforming to the first phase of our credit cycle model. But instead of inflation arising from excess demand, we have stagflation, the result of excess money in circulation. Consequently, the prospect is for increasing interest rates without the usual economic recovery. This statement needs further amplification: the tentative signs of recovery are misleading in the US, the UK and much of Europe. The unprecedented quantities of raw money injected into these economies have been about as effective as trying to kick life into a dead body. Meanwhile, the emerging market economies, which have fuelled export demand for the West, are over-heating; credit is tightening and these countries are in the later stages of a conventional credit cycle. The potential for emerging markets to create a tide of rising employment in the mature economies is not there, because this tide has turned and is now on the ebb. OOO ALASDAIR MACLEOD / LINK 28 March

16 CHARTS THAT MAKE YOU GO Hmmm SOURCE: VIZUALISING ECONOMICS A $10,000 house in 1890 would be worth almost the same in real dollars in 2010 but more than $350,000 in nominal dollars in Which matters to the home seller, real or nominal prices? If a seller is holding a mortgage then the question is: Can I sell for more or less than I owe? Since that loan amount is not adjusted for inflation then the nominal value is more importent both the seller and the mortgage holder. It is when nominal prices fall that banks have trouble with high rates of mortgage defaults. But if you are looking at the long-term value of real estate as an investment (compared to stocks or bonds) then you need to take into account the real growth. OOO VISUALIZING ECONOMICS / LINK Uncertainty over the extent of the damage caused by the earthquake in northeast Japan on March 11th, and the associated radiation leak at the Fukushima Dai-ichi power station 140 miles (225km) north of Toyko, has made trading on Japan s stockmarket an eventful affair. The Nikkei 225 index fell 17.5% in the three trading days following the catastrophe, wiping some 37 trillion ($458 billion) off equities. This compares unfavourably with market reactions to other disasters. Once the New York Stock Exchange had reopened six days after the September 11th terrorist attacks, the S&P 500 fell by 11.6% over five trading days, but after a further 14 days it had recovered to its pre-disaster level. After Japan s last severe earthquake in the city of Kobe in 1995 the Nikkei 225 fell by 7.6% over the next four trading days, but it did not recover to its pre-earthquake level for another 11 months. The Nikkei 225 regained some lost ground today, closing up 5.7%. The Japanese will be hoping for the same bounce back in their own fortunes. OOO ECONOMIST / LINK SOURCE: THE ECONOMIST 28 March


18 CHARTS THAT MAKE YOU GO Hmmm Whichever way you look at it, the percentage of gold as a component of either global assets, financial assets or the typical pension fund makes it hard to justify talk of a bubble... CLICK ON ANY CHART TO ENLARGE SOURCE: CASEY RESEARCH SOURCE: BULLION MANAGEMENT GROUP SOURCE: CASEY RESEARCH SOURCE: SPROTT AM 28 March

19 WORDS THAT MAKE YOU GO Hmmm For those amongst you who haven t read G. Edward Griffin s book THE CREA- TURE FROM JEKYLL ISLAND here is a rare treat indeed. Glenn Beck explains the creation of the Federal Reserve Bank to, well, his audience. He manages to include Fat Presidents, the sacrifice of chickens, Chairman Mao, Colonel Sanders and more mugging for the camera/ faux amazement than you could shake a long, pointy stick at. Don t let the craziness swallow you up... Close behind Beck in terms of entertainment value, but an infinitely more astute observer of the world, is Gerald Celente of the Trends Research Institute. Today, Celente talks to Eric King about the unrest in the Middle East, ponders how different the world would be if the Middle East exported broccoli instead of oil, wonders aloud just who the West is supporting in Libya and once again pulls no punches when explaining just who s in charge. To hear the disdain dripping from Celente s every word is quite extraordinary. Here s a look at the gold frenzy enveloping Chinese buyers through the eyes of the Chinese themselves. Sales are booming as locals look to the yellow metal as a safe form of saving. Buying gold is in the DNA here in Asia - unlike the West, the people just inherently get buying gold. Look for that to continue March

20 and finally For those of you unfamiliar with him, meet Charlie Brooker. Charlie is an English commentator who specializes in the absurdities of present-day television. A friend of mine who lives in Tokyo sent this to me as he felt it struck a chord in terms of the anger local residents are feeling about the coverage of events in Japan these past couple of weeks. He wasn t to know that I d written something in these pages a few days prior, that covered the same ground. Charlie s just a lot funnier than me. Enjoy this one, but, by way of warning to anyone of a sensitive nature, this video contains an expletive. Just one, an F-bomb, but it s used in relation to a tweet sent by 50 Cent at the height of the panic - so I feel it s probably justified. See for yourselves... Hmmm SUBSCRIBE UNSUBSCRIBE COMMENTS THINGS THAT MAKE YOU GO HMMM March