Monday, March 15, 2010

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Thursday, March 11, 2010

A debate on where the US economy is headed

I am leaning toward Rosenberg's view on this.

Wednesday, March 10, 2010

Goldman and bubbles

Blaming Goldman Sachs for every bubble sounds silly. But is regulation the solution? Maybe, or maybe not --- Bubbles also happens in tightly regulated market, say, in China.

Maybe what we need is smart regulation. Or, bubble is just an integral part of capitalism --- As long as there are animal spirits and human greed, bubble can never be rid of.

Ten years after bubble

Comparing market performance after big crashes...

(click to play video; source: FT)

The pattern is the market usually go on sideways for a VERY LONG TIME after big crash. This offers a sober lesson for those who got too excited in predicting a robust recovery.

Tuesday, March 09, 2010

New financial indicator predicts downturn ahead

A new financial indicator predicts economy is likely to suffer downturn ahead.

This is from Jim Hamilton's Econbrowser blog. More details about this new indicator.

Most recently, researchers have tried to gauge the degree of financial stress using indicators such as the LIBOR-OIS spread ([1], [2]) or deviations of yields from predictions of interest rate models (e.g., the recent paper by Christensen, Lopez, and Rudebusch). There are also a number of composite indexes that various private-sector analysts rely on, such as the Bloomberg financial conditions index.

Two private-sector analysts (Jan Hatzius of Goldman Sachs and Peter Hooper of Deutsche Bank) have recently teamed up with three academics (Rick Mishkin of Columbia, Kermit Schoenholtz of NYU, and Mark Watson of Princeton) to produce a new financial conditions index that attempts to combine the information of 44 separate series including those mentioned above along with a great number of others. One of the differences between their approach and previous work is that HHMSW seek to isolate the separate information of the financial indicators from aggregate business cycle movements by looking at the residuals from a regression of each indicator on lags of inflation and real GDP growth rates.

Monday, March 08, 2010

Shiller: Double-dip is less likely

The more plausible scenario is very slow growth. Bob Shiller also has some interesting comments on confidence and bubbles, how they reinforce each other.

Saturday, March 06, 2010

Musing on world economy with Joe Stiglitz

Joseph Stiglitz interview with Charlie Rose.

The Inevitable Endgame

Interview of Chris Wood, top ranked Asian Equities Strategist. He talks about the outlook for China, Europe and the US.

He predicts the inevitable endgame will be a systemic government debt crisis in the Western world.

Friday, February 19, 2010

Leading indicator shows chance of 'double dip'

Following the sign of double-dip in housing market, the Leading Economic Indicator (or LEI) shows double-dip scenario is close to reality.

(click to enlarge; graph courtesy of SocGen)

Poor countries pay for undervalued Yuan

Arvind Subramanian of Peterson Institute argues that weak Yuan acts as export subsidy and import tariff, the US gets to enjoy cheaper imports at Chinese expense, but the ultimate victim of China's currency policy is poorer developing countries.

It Is the Poor Who Pay for the Weak Renminbi

by Arvind Subramanian, Peterson Institute for International Economics

China's exchange rate policy has largely been viewed through the prism of global imbalances. That has had three unfortunate consequences. It has allowed China to deflect attention away from its policy. It has obscured the real victims of this policy. And it has made political resolution of this policy more difficult.

No sooner is China's exchange rate policy criticized for creating global imbalances, and hence contributing to the recent global financial crisis, than the door is opened for China to muddy the intellectual waters. Why single us out, the Chinese say? Why not the other surplus-running countries such as Japan or Germany or the oil exporters? And, in any case, countries on the other side of the imbalance—namely, the large current account deficit-running countries—should carry the greatest responsibility for pursuing irresponsible macroeconomic and regulatory policies that led to "excessive consumption." This debate cannot be settled. But inconclusiveness is just what China needs—and creates—to escape scrutiny of its policies.

The second consequence of the global imbalance perspective is that it has created an opposition between current account deficit and current account surplus countries, which has become a slanging match between the United States and China. But an undervalued exchange rate is above all a protectionist trade policy, because it is the combination of an import tariff and an export subsidy. It follows therefore that the real victims of this policy are other emerging market and developing countries—because they compete more closely with China than the United States and Europe, whose source of comparative advantage is very different from China's. In fact, developing countries face two distinct costs from China's exchange rate policy.

In the short run, with capital pouring into emerging market countries, their ability to respond to the threat of asset bubbles and overheating is undermined. Emerging market countries such as Brazil, India, and South Korea are loath to allow their currencies to appreciate—to dampen overheating—when that of a major trade rival is pegged to the dollar.

But the more serious and long-term cost is the loss in trade and growth in poorer parts of the world. Dani Rodrik of Harvard University estimates that China's undervaluation has boosted its long-run growth rate by more than 2 percent by allowing greater output of tradable goods, a sector that was the engine of growth and an escape route from underdevelopment for postwar successes such as Japan, South Korea, and Taiwan.

Higher tradable goods production in China results in lower traded goods production elsewhere in the developing world, entailing a growth cost for these countries. Of course, some of these costs may have been alleviated by China's rapid growth and the attendant demand for other countries' goods. But China's large current account surpluses suggest that the alleviation is only partial.

These emerging market victims of China's exchange rate policy have remained silent because China is simply too big and powerful for them to take on. And this despite the fact that disaffected constituencies now encompass not just companies but also central bankers, who have found macroeconomic management constrained by renminbi policy.

Hence the third consequence. By default, it has fallen to the United States to carry the burden of seeking to change renminbi policy. But it cannot succeed because China will not be seen as giving in to pressure from its only rival for superpower status. Only a wider coalition, comprising all countries affected by China's undervalued exchange rate, stands any chance of impressing upon China the consequences of its policy and reminding it of its international responsibilities as a large, systemically important trader.

It is time to move beyond the global imbalance perspective and see China's exchange rate policy for what it is: mercantilist trade policy, whose costs are borne more by countries competing with China—namely other developing and emerging market countries—than by rich countries. The circle of countries taking a stand against China must be widened beyond the United States to ramp up the pressure on it to repudiate its beggar-thy-neighborism. But progress also requires that the silent victims speak up. Emerging market and developing countries must do a "Google" on China.

Wednesday, February 17, 2010

Musing on China's real estate bubble

More than 60 percent of investors surveyed by Bloomberg on Jan. 19 said they viewed China as a bubble, and three in 10 said it posed the greatest downside risk.  Read full report here.

Every recession is different, so is every bubble. Here are some thoughts I wanted to share:

1. China's real estate bubble will burst; government stimulus only delays the day of reckoning, but won't be able to prevent it;

2. The impact will not be great enough to slow down China's long term economic growth. This is because,
    a) China has high savings rate, and the household balance sheets are not highly leveraged;
    b) China is a developing country --- it grows at a much faster pace than developed economies;
    c) China's huge population and its demand for urban housing will mitigate the impact.

3. Similar to Japan, China's real estate bubble was fueled by currency appreciation expectation.  In China's case, the fixed exchange rate system coupled with the fastest economic growth in the world simply invite currency speculation and attract short-term capital inflows.  A big chunk of these short-term money found its way into real estate market, although China has tight capital control. 

Tuesday, February 16, 2010

Market has changed direction

David Rosenberg looks at the market direction from its 120-day change.

It clearly shows the market peaked in last August, then went sideway until last December; from last December, the market has been trending down.

This bear market rally was so long that surprised every professional investor. Now it's the time to reckon.

(click to enlarge)
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Europe's shakiest to safest

Following my previous post on Ring of Fire, here is a chart from Economist Magazine that gives you an idea of which countries stand as the riskiest in Europe,  if debt crisis were to hit.

Why did Europe blink?

WSJ's analysis on Greece bailout:

Why did Europe blink?

The decision by European leaders to offer Greece support, albeit unspecified, likely owed more to fears for the weakened European banking system and its ability to supply credit to a fragile recovery than fraternal concern for a struggling neighbor.

Shares in euro-zone banks slumped as the sovereign-debt crisis unfolded, with Greek banks tumbling more than 50%. Aside from the political imperative for leaders to make a statement, the fear of contagion to the wider euro-zone economy was real.

Falling government-bond prices themselves aren't the biggest problem. Most European banks hold government bonds as available for sale assets, which means mark-to-market losses are recognized through the profit-and-loss account only when they become impaired. And although mark-to-market losses are recorded on the balance sheet as a reserve, it doesn't count under current Basel rules as a deduction against regulatory capital. If governments continue to pay their coupons and the bonds remain eligible for central-bank facilities, then bank capital or liquidity positions should be unaffected.

But there are several channels through which contagion can operate. Rising government-bond yields could push up yields on other assets, triggering mark-to-market losses on trading books. They also could lead to higher bank-funding costs, because bank credit-default swaps tend to track sovereign swaps. At the same time, fiscal tightening could tip economies back into recession, leading to higher bad-debt charges. If gross domestic product fell 1%, loan volumes fell 2%, nonperforming loans increased 5% and bond spreads widened, Credit Suisse estimates the European bank sector's 2010 earnings and return on equity would be nearly halved.

But European leaders likely also had their eye on an even bigger tail risk: That sovereign-debt fears could lead to a collapse in lending to vulnerable countries. The exposure of French banks to Portugal, Ireland, Italy, Greece and Spain is equivalent to 30% of GDP, according to Stephen Jen of Bluegold Capital Management. Irish and Portuguese banks also are heavily exposed to those countries. Austrian banks' exposure to Eastern Europe is equivalent to 54% of GDP. These linkages between banking systems are a potentially potent transmission mechanism, making it hard to put a fence around the Greek sovereign crisis.

No wonder European leaders felt unable to leave Greece to the mercy of the markets. But in offering support, they are merely following a familiar pattern established during the crisis of shifting responsibility for funding the global debt pile from credit markets to the banks, from banks to sovereigns and now from weak sovereigns to stronger ones. Once this transfer is complete, the debt pile really will have nowhere else to go.

Wednesday, February 10, 2010

Understand China's financial system

Disentangle China's 'complex' financial system (source: Economist Magazine). 

No surprise here ---the deep connections between bankers, and China's Communist Party members, and their sons and daughters. 

To be fair, every system is evolutionary, and it takes time to improve.  But there is no way to guarantee China's financial system will become more transparent.  This does not look good to me.

Something about China's consumption

According to Zhang Shugang, a well-known economist in China, China's consumption grew 15.5% over past year.  On the surface, this is exactly what we needed to re-balance China's highly skewed, investment-driven economy

Not yet...

Further look at the data:  69% of the total consumption came from either housing or automobile purchase, with housing expenditure accounting for 55%.  This is out of whack.  Think about how many people were actually buying for speculation only...animal spirits and bubble show up everywhere.

This is a bubble that will eventually go bust.

Tuesday, February 09, 2010

Big test coming for Euro

David Rosenberg warns don't take Euro's longevity for granted:

Greece today may well be the touch-off point for market instability just as Thailand was back in July 1997 — who would have thought a Baht devaluation would have touched off a major Asian financial crisis. Then again, who thought the subprime mortgage market would unleash a broad credit collapse — certainly not the folks at the Federal Reserve. And, as for the Euroland, don't take its longevity for granted either. Go back to the history books and read about how long other currency unions lasted in that part of the world in the past (like the Latin Monetary Union circa 1867 or the Scandinavian Monetary Union circa 1873).

Maybe it's too early to be too much worried about Euro, but be reminded that the fate of Euro had always been a jousting between two of my favorite economists, Milton Friedman and Bob Mundell. 

***Read this classic historical debate*** at University of Chicago between the two great minds.

Fogel on world economy in 2040

Robert Fogel, winner of Nobel prize in economics in 1993, predicts China will dominate the world economy by 2040 (see the table below).

 His prediction raised some heated debate in economics profession. In a recent NBER paper, he explained why he thinks:

1. China's future growth rate will be about 8% per year between 2000 and 2040;
2. EU-15 will only grow at 1.2% per year between 2000 and 2040;
3. The U.S. GDP between the same years will grow at 3.7% per year.

Betting against Euro

Traders are increasingly betting against Euro (source: FT):

Traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis.

Figures from the Chicago Mercantile Exchange, which are often used as a proxy of hedge fund activity, showed investors had increased their positions against the euro to record levels in the week to February 2.

The build-up in net short positions represents more than 40,000 contracts traded against the euro, equivalent to $7.6bn. It suggests investors are losing confidence in the single currency's ability to withstand any contagion from Greece's budget problems to other European countries.

Amid growing nervousness in financial markets over whether countries including Spain and Portugal can repair their public finances, Madrid on Monday launched a PR offensive to try to assuage investors' fears.

Elena Salgado, Spanish finance minister, and José Manuel Campa, her deputy, flew to London to meet bondholders.

They sought to allay doubts about Spain's creditworthiness by repeating promises to cut its budget deficit to 3 per cent of gross domestic product by 2013 from 11.4 per cent last year. "We'll make the adjustment that's necessary," Mr Campa said. But their disclosure that the treasury planned to raise a net €76.8bn through debt issuance this year unsettled markets further. The projected sum to be raised was lower than the €116.7bn of 2009 but higher than many investors had expected.

The news sent yields on Spanish government bonds, which have an inverse relationship with prices, sharply higher. The premium demanded by investors to hold the country's debt over German bunds rose to 1 percentage point.

The Spanish government is convinced it is being unfairly treated by foreign investors and the media. José Blanco, Spain's public works minister, hit out at "financial speculators" for attacking the euro and criticised "apocalyptic commentaries" about Spain's finances.

Appealing for patriotism, Mr Blanco said in a radio interview: "Nothing that is happening in the world, including the editorials of foreign newspapers, is casual or innocent."

The single currency fell to an eight-month low of $1.3583 on Friday but recovered a little on Monday to $1.3683. Analysts said sentiment towards the euro had soured because of the increasing concern over Greece's fiscal problems.

Thomas Stolper, economist at Goldman Sachs, said: " Behind this intense focus on Greece obviously is the long-standing unresolved issue of how to enforce fiscal discipline in a currency union of sovereign states."

Sunday, February 07, 2010

Is China rising as a science superpower?

Reports from Bank of Finland:

China rising as science superpower; huge growth in research activity. A Financial Times story on Monday (Jan. 25) compiled data from Thomson Reuters and Web Science database to show Chinese researchers published about 112,000 scientific articles in peer-reviewed journals in 2008. US researchers led the pack with the most published articles (333,000).

Among the BRIC countries, China has made the most impressive gains in research publications, with notable strengths in the areas of chemistry and materials science. The quality of the science in Chinese papers still is variable, but clearly the Chinese are increasingly working across borders with members of the international research community and a growing number of foreign researchers are publishing jointly with their Chinese colleagues. Generally speaking, the quality of Chinese research is improving.
Brazil has also made huge strides in increasing its out-put of scientific articles, with particular expertise shown in the areas of agriculture and bioscience. In contrast, India, and in particular Russia, failed to live up to expectations of increasing research prowess.

China's heavy investment in education and R&D during the past decade is now coming to fruition with China joining other research leaders. The return of the Chinese re-searchers who have studied and worked in North America and Europe are playing an important role in China's development. China has also been successful in translating basic science advances into commercial applications. This phenomenon is reflected, e.g. in the large increase in international patent applications.

Two graphs extracted from the Thomson Reuters' report on China's research output:

(click to enlarge)

China now produces the world's second most research publications, only behind the United States.

Where are China's research publications concentrated?

Eurozone's debt contagion

Interview of Harvard professor Nail Ferguson. Will Germany-France bail out Greece, Spain and Portugal?

Remember Milton Friedman's prediction --- "Euro can't survive a major crisis." Let's watch and see.

(update 1) Rolfe Winkler writes on Reuters on the same issue. He outlined three possible outcomes.

1) The PIIGS (acronym for Portugal, Ireland, Italy, Greece and Spain) cut their budgets to pay back debt. Such austerity programs are typically very difficult to get done in democracies. Deficit spending stays high long past the point that it’s possible to work off debt over any reasonable period. To successfully dig out of the hole requires cuts so deep, voters never agree to them.

2) Europe bails them out, which is the easiest solution in the short-run. Richer European countries certainly have the wherewithal to bail out a small country like Greece or Portugal. But it’s a dangerous precedent to set. What about Spain? It’s 14% of the Euro economy compared to 6% for Portugal/Ireland/Greece combined. If economies keep spending with an eye towards a bailout from the ECB, eventually you get #3.

3) The monetary union breaks apart. The customary way out of a debt crisis is to devalue one’s currency, see Argentina in 2001. It couldn’t maintain it’s dollar peg and still service its debt, so it devalued its currency and defaulted on debt. But this locked the country out of the international capital markets and drove them into a deep, though brief, Depression. For Greece to devalue, it would have to pull out of the Euro, pass a law that it’s debts are payable in new local currency and then devalue.

Beijing Consensus, no more

Yang Yao, Director of the China Center for Economic Research at Peking University, writes on Foreign Affairs that Beijing's ongoing efforts to promote growth are infringing on people's economic and political rights. In order to survive, the Chinese government will have to start allowing ordinary citizens to take part in the political process.

In my view, this so-called Beijing Consensus never existed. It's the fantasy of some academic scholars. It should not be treated as a universal development model and applied to other developing countries.

China's development model may be very efficient, but it lacks higher moral ground. It's the outcome of three decades of gradualist policy evolution during a very special transitioning period. What China needs is more individual freedom and less government intervention in both economic and political spheres.

Read Yang Yao's piece, "The End of the Beijing Consensus".

Saturday, February 06, 2010

Market and the Dollar

This is a remarkable graph showing the negative correlation between the market and US dollar.

Thursday, February 04, 2010

6-sense technology

The current state of six-sense technology -- connecting physical world to digital world.


Never underestimate what human capital and knowledge can do. I am optimistic that in 50 years, human welfare will be at much higher level than what any of us can possibly imagine today.

Thanks to its immigration policy, the U.S. is still leading the pack.

Paulson: the US was very close to financial collapse

Paulson's interview with Bloomberg.

At one point, he talked to his wife, Wendy, on the cell phone, "I am scared...pray for me."

Also watch my previous post on Inside the Meltdown from Frontline.

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Paul Volcker on prop trading restrction

Bank credit less tight

click graph below to play video, from FT:

The problem with Euro-zone bond

Why euro-zone bond is a bad idea (from WSJ):

Is a euro-zone bond issue the answer to Greece's problems? Prime Minister George Papandreou unsurprisingly thinks it a good idea. But he and other European leaders shouldn't waste time fantasizing about it. Even if there weren't huge technical, political, economic and legal headaches to solve, a euro-zone bond could cause more problems than it solves at present.

The attraction of a euro-zone bond is that it would provide cheaper funding to countries whose borrowing costs have risen sharply as a result of the crisis: mainly Greece, but also Portugal and Ireland. But any advantages in terms of increased European solidarity are far outweighed by the costs associated by a huge increase in moral hazard.

Issuing a euro-zone bond would remove all incentive for weaker states to take difficult decisions; they would be able to spread the pain to taxpayers in other countries instead. Borrowing costs would likely rise for other euro-zone members, including those viewed by the markets as having maintained relative fiscal solidity, such as Germany, Finland and the Netherlands, ultimately leading to tax hikes or spending cuts.

The euro-zone's "no bail-outs" approach would have been shown to be fatally flawed—and the currency bloc's credibility, already damaged by failures to enforce sanctions against countries breaking the Stability and Growth Pact rules, would be further damaged.

In the longer-term, and in calmer economic waters, a shift to issuing debt at the euro-zone level might make sense—but only if introduced for the right reasons. A common euro-zone debt market could be more liquid than the multitude of national markets, making the euro more attractive as a reserve currency; this is an aspect that benefits U.S. Treasurys, after all. But this would require a radical centralization of political authority, and further changes to European treaties. Given the trauma of the Lisbon treaty process, few would have appetite for it now.

Wednesday, February 03, 2010

Ring of Fire

From Bond King, Bill Gross:

(click to enlarge)

The most vulnerable countries in 2010 are shown in the chart “The Ring of Fire.” These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth.

How to destroy American jobs

Matt Slaughter is right on the money. Obama's proposed tax on US multinational firms only destroy American jobs, not protect them:

How To Destroy American Jobs

by Matthew Slaughter

Mr. Slaughter is associate dean and professor at the Tuck School of Business at Dartmouth, research associate at the National Bureau of Economic Research, and senior fellow at the Council on Foreign Relations. From 2005 to 2007 he served as a member of the White House Council of Economic Advisers.

Deep in the president's budget released Monday—in Table S-8 on page 161—appear a set of proposals headed "Reform U.S. International Tax System." If these proposals are enacted, U.S.-based multinational firms will face $122.2 billion in tax increases over the next decade. This is a natural follow-up to President Obama's sweeping plan announced last May entitled "Leveling the Playing Field: Curbing Tax Havens and Removing Tax Incentives for Shifting Jobs Overseas."

The fundamental assumption behind these proposals is that U.S. multinationals expand abroad only to "export" jobs out of the country. Thus, taxing their foreign operations more would boost tax revenues here and create desperately needed U.S. jobs.

This is simply wrong. These tax increases would not create American jobs, they would destroy them.

Academic research, including most recently by Harvard's Mihir Desai and Fritz Foley and University of Michigan's James Hines, has consistently found that expansion abroad by U.S. multinationals tends to support jobs based in the U.S. More investment and employment abroad is strongly associated with more investment and employment in American parent companies.

When parent firms based in the U.S. hire workers in their foreign affiliates, the skills and occupations of these workers are often complementary; they aren't substitutes. More hiring abroad stimulates more U.S. hiring. For example, as Wal-Mart has opened stores abroad, it has created hundreds of U.S. jobs for workers to coordinate the distribution of goods world-wide. The expansion of these foreign affiliates—whether to serve foreign customers, or to save costs—also expands the overall scale of multinationals.

Expanding abroad also allows firms to refine their scope of activities. For example, exporting routine production means that employees in the U.S. can focus on higher value-added tasks such as R&D, marketing and general management.

The total impact of this process is much richer than an overly simplistic story of exporting jobs. But the ultimate proof lies in the empirical evidence.

Consider total employment spanning 1988 through 2007 (the most recent year of data available from the U.S. Bureau of Economic Analysis). Over that time, employment in affiliates rose by 5.3 million—to 11.7 million from 6.4 million. Over that same period, employment in U.S. parent companies increased by nearly as much—4.3 million—to 22 million from 17.7 million. Indeed, research repeatedly shows that foreign-affiliate expansion tends to expand U.S. parent activity.

For many global firms there is no inherent substitutability between foreign and U.S. operations. Rather, there is an inherent complementarity. For example, even as IBM has been expanding abroad, last year it announced the location of a new service-delivery center in Dubuque, Iowa, where the company expects to create 1,300 new jobs and invest more than $800 million over the next 10 years.

read more here.

Tuesday, February 02, 2010

Implications of Obama's Budget

Obama's 2011 spending plan is way above historical average.

(click to enlarge)

This may be inevitable after a big financial crisis and government stimulus is badly needed. But big government deficit will have its consequences.

From Carmen Reinhart and Kenneth Rogoff:

As government debt levels explode in the aftermath of the financial crisis, there is  growing uncertainty about how quickly to exit from today’s extraordinary fiscal stimulus. Our research on the long history of financial crises suggests that choices are not easy, no matter how much one wants to believe the present illusion of normalcy in markets.

Unless this time is different – which so far has not been the case – yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis.In previous cycles, international banking crises have often led to a wave of sovereign defaults a few years later. The dynamic is hardly surprising, since public debt soars after a financial crisis, rising by an average of over 80 per cent within three years. Public debt burdens soar owing to bail-outs, fiscal stimulus and the collapse in tax revenues. Not every banking crisis ends in default, but whenever there is a huge international wave of crises as we have just seen, some governments choose this route.

We do not anticipate outright defaults in the largest crisis-hit countries, certainly nothing like the dramatic de facto defaults of the 1930s when the US and Britain abandoned the gold standard. Monetary institutions are more stable (assuming the US Congress leaves them that way). Fundamentally, the size of the shock is less. But debt burdens are racing to thresholds of (roughly) 90 per cent of gross domestic product and above. That level has historically been associated with notably lower growth.While the exact mechanism is not certain, we presume that at some point, interest rate premia react to unchecked deficits, forcing governments to tighten fiscal policy. Higher taxes have an especially deleterious effect on growth. We suspect that growth also slows as governments turn to financial repression to place debts at sub-market interest rates.

I don't think there will be a debt crisis, but certainly expect rising yields on government bonds and further weakening US dollar.

Monday, February 01, 2010

"The British screwed us", says Paulson

More from Hank Paulson's memoir ON the Brink, on the two days that led to Lehman's bankruptcy:

I had gone to bed modestly optimistic about our chances of saving Lehman. The Barclays bid was proceeding, and Diamond had a board meeting scheduled for early that morning in London.

Tim spoke with Diamond after the Barclays board meeting, at 7:15 a.m. New York time, and Bob warned him that Barclays was having problems with its regulators. Forty-five minutes later, I joined Tim in his office to talk with Diamond and Varley, who told us that the FSA (Financial Services Authority of the U.K.) had declined to approve the deal. I could hear frustration, bordering on anger, in Diamond's voice.

We were beside ourselves. This was the first time we were hearing that the FSA might not support the deal. Barclays had assured us that they were keeping the regulators posted on the transaction. Now they were saying that they didn't understand the FSA's stance. At 10 a.m., we met with the bank chiefs again, and I told them we had run into some regulatory issues with Barclays but were committed to working through them. The CEOs presented us with a term sheet for the deal. They had agreed to put up more than $30 billion to save their rival. If Barclays had committed to the deal, we would have had industry financing in place.

At 11 a.m., I went back upstairs, and soon got on the phone with (British Finance Minister) Alistair Darling, who wanted a report on Lehman. I told him we were stunned to learn that the FSA was refusing to approve the Barclays' transaction.

He made it clear, without a hint of apology in his voice, that there was no way Barclays would buy Lehman. He offered no specifics, other than to say that we were asking the British government to take on too big a risk, and he was not willing to have us unload our problems on the British taxpayer.

It was shortly before 1 p.m. when Tim, (Security and Exchange Commission Chairman) Chris (Cox) and I addressed the CEOs again. I was completely candid. Barclays had dropped out, and we had no buyer for Lehman.

"The British screwed us," I blurted out, more in frustration than anger. I'm sure the FSA had very good reasons for their stance, and it would have been more proper and responsible for me to have said we had been surprised and disappointed to learn of the UK regulator's decision, but I was caught up in the emotion of the moment.

Back in my temporary office on the 13th floor, a jolt of fear suddenly overcame me as I thought of what lay ahead of us. Lehman was as good as dead, and AIG's problems were spiraling out of control. With the U.S. sinking deeper into recession, the failure of a large financial institution would reverberate throughout the country—and far beyond our shores. It would take years for us to dig ourselves out from under such a disaster.

All weekend I'd been wearing my crisis armor, but now I felt my guard slipping. I knew I had to call my wife, but I didn't want to do it from the landline in my office because other people were there. So I walked around the corner to a spot near some windows. Wendy had just returned from church. I told her about Lehman's unavoidable bankruptcy and the looming problems with AIG.

"What if the system collapses?" I asked her. "Everybody is looking to me, and I don't have the answer. I am really scared."

I asked her to pray for me, and for the country, and to help me cope with this sudden onslaught of fear. She immediately quoted from the Second Book of Timothy, verse 1:7—"For God hath not given us the spirit of fear, but of power, and of love, and of a sound mind."

read more here from WSJ

What Hank Paulson had feared

Excerpts from Hank Paulson's memoir, "ON the Brink".  The former Treasury Secretary feared a total collapse of US dollar; going down of both Morgan Stanley and Goldman Sachs. He also blamed UK authority for failing to let Barclay take over Lehman Brothers, then triggered a free fall of the market in Oct. 2008. Reports FT:

Hank Paulson feared there would be a run on the dollar during the early phase of the financial crisis when global concerns were focused on the US, the former Treasury secretary has told the Financial Times.

"It was a real concern," Mr Paulson said in an interview ahead of the release today of his memoir On the Brink . A dollar collapse "would have been catastrophic," he said. "Everything that could go bad did not go bad. We never had the big dislocation of the dollar."

When the crisis escalated and went global with the failure of Lehman Brothers in September 2008, the dollar rallied - but Mr Paulson had to grapple with a firestorm of financial failures.

He feared Goldman Sachs and Morgan Stanley would go down along with Washington Mutual and Wachovia.

Lloyd Blankfein, Goldman Sachs chairman, told him that Goldman would be "next" if speculators succeeded in bringing down Morgan Stanley, the former Treasury secretary said.

US officials explored the possibility of mergers between JPMorgan and Morgan Stanley, Goldman and Citigroup, or Goldman and Wachovia, before settling on a "plan B" to turn Morgan Stanley and Goldman into banks with access to central bank loans.

Even then, Morgan Stanley was not safe until the US Treasury helped seal an investment by Japan's Mitsubishi UFJ, Mr Paulson writes.

The frenzied manoeuvring came in the three-week period between the failure of Lehman on September 15, 2008, and Columbus Day weekend in early October, when the global financial system was on the verge of meltdown.

"Banks were going down like flies," Mr Paulson told the FT. As his book details, he was desperately scrambling to secure Tarp bail-out funds from Congress.

"The timing could not have been worse since we were months or weeks from the election so you had the collision of markets and politics."

Although a Republican, Mr Paulson found it harder to deal with John McCain than Barack Obama - raising the interesting (and unanswered) question of which candidate Mr Paulson voted for.

Mr Paulson said that the turning point in the crisis came when - armed at last with Tarp equity - the US joined other Group of Seven nations to announce comprehensive interventions to guarantee bank funding and access to capital on Friday, October 10.

Three days later, Mr Paulson pressured nine top US financial institutions into accepting $125bn in Tarp capital. "I do think it was the defining act," Mr Paulson said.

Before that weekend, he said: "We were always running behind this. It was always bigger than we were".

Mr Paulson said the US authorities lacked essential tools to deal with a crisis - above all a controlled bankruptcy regime for non-bank financial firms.

He hopes his book conveys "the pace at which things were moving and the number of decisions that had to be made in very short time-frames".

Mr Paulson was surprised by the vehemence of the public reaction against bail-outs. He told the FT there was "a disconnect" between the way policymakers saw their actions and the way the public perceived them.

"We knew, I knew that when the markets froze there was going to be a painful impact on the economy a number of weeks out."

Mr Paulson is frustrated that people do not pay more attention to disasters averted by timely actions - including the move to seize control of Fannie Mae and Freddie Mac.

Instead, most debate centres on the failure to stop Lehman from collapsing, and the decision to rescue insurance giant AIG. Mr Paulson said Lehman was "like a slow-motion car crash".

Critics say the Treasury should have deployed its sole pre-Tarp source of capital, the Exchange Stabilisation Fund, to backstop a rescue. However, Mr Paulson said Treasury lawyers had been through this during the Bear Stearns crisis six months earlier and concluded that it would not be lawful.

Others fault top US officials for not doing a better job of preparing for a Lehman collapse.

Mr Paulson said the US was taken by surprise by the UK bankruptcy administrator's decision to seize hedge fund assets held by Lehman - a move he said was "devastating".

He also admitted "I did not see the money markets moving as quickly as they did" after the Lehman collapse. But he said there were limits to what could have been done in general to mitigate a Lehman failure without precipitating its immediate collapse.

On AIG, Mr Paulson said he had nothing to do with the controversial decision to pay counterparties at par - and found out about it only in December when AIG made a public disclosure.

His book hints that the Treasury was less than enthusiastic about supporting the original Federal Reserve loan with later Tarp equity - but Mr Paulson refused to discuss AIG further.

Looking back, Mr Paulson is confident that - notwithstanding criticism - the big calls were the right ones.

"This Monday morning quarter-backing misses the point - that guess what, we did take the important actions that it took to stop the system from collapsing."

Trust placed in a 'Higher Power'

"I left the New York Fed before 9pm, optimistic about the prospects for a deal. The industry was doing its part to come up with funding, and I had reason to believe we would find a solution to Barclays' need for a shareholder vote.

"Anticipating another sleep-deprived night, I arrived back at the hotel exhausted. I went into the bathroom of my room and pulled out a bottle of sleeping pills I'd been given. As a Christian scientist, I don't take medication, but that night I desperately needed rest.

"I stood under the harsh bathroom lights, staring at the small pill in the palm of my hand. Then I flushed it - and the contents of the entire bottle - down the toilet. I longed for a good night's rest. For that, I decided, I would rely on prayer, placing my trust in a Higher Power."

Excerpt from On the Brink, Saturday September 13 2008 (during the Lehman Brothers crisis weekend)

Sunday, January 31, 2010

Market is trending down

Market technical indicators all point to downward. Looks like the the long-anticipated market correction is looming.

(click to play to video analysis)

How strong is economic recovery?

Analysis of Q4 GDP growth number.

Most growth came from inventory re-building.

Interview of John Silvia, chief economist at former Wachovia, and now part of Wells Fargo. In my book, John has been an very accurate macro forecaster.

Comedy on Obama's take on bankers

Obama Takes On Bankers

Thursday, January 28, 2010

Foreclosures still rising

(graph courtesy of Casey Research)

Roubini on economic outlook

The ugly truth behind dollar and euro

Dollar and Euro, which is the less-worse currency?

The dollar and the euro are engaged in an ugly contest.

In a long slide since 2000, the dollar has lost 41% against the euro. After a brief rebound as investors sought safety during the worst of the financial crisis, the greenback again weakened through 2009. But that could change this year.

That might seem odd as, on the face of it, there is little to recommend the dollar. A fed-funds target rate hovering at around zero, quantitative easing and ballooning deficits all serve to undermine the currency. Economic data, especially in consumer-sensitive areas like housing and employment, remain weak.

Ugly as that is, Europe is no model of perfection either. Greece, the obvious blemish, points to a deeper malaise. As Brown Brothers Harriman & Co. says, incomplete political union leaves the euro zone without effective mechanisms to enforce fiscal discipline in member states.

Other countries—like Greece—have lost competitiveness over the past decade but could not devalue, and relied on fiscal expansion instead. If Greece calls for a bail-out, countries like Germany will have to weigh the risks of raising moral hazard versus the risks of destabilizing markets by standing firm—an unpalatably Lehman-like quandary. The need for more rigorous fiscal policing by definition suggests further erosion of member-state sovereignty will be required, setting the stage for protracted political wrangling.

China's artificially low renminbi may be compounding the euro zone's problems. Lombard Street Research reckons European businesses bear the brunt in terms of loss of market share in international trade.

China's recent moves to tighten monetary policy might suggest some relief on this front. But the more pertinent effect, from a currency perspective, is to raise anxieties in financial markets—as observed in recent stock sell-offs and the jump in volatility measures like the VIX index. As the experience of late 2008 showed, if things turn ugly, investors tend to close their eyes and embrace the dollar.

US dollar recently had a strong upward trend, for the first time since June 2009, it's about to break the 200-day moving average.

(click to enlarge)

Is China's real estate bubble ready to burst?

Predicting bubble in notoriously difficult, not to mention predicting when the bubble will burst. Nonetheless, I do think China's real estate bubble will burst eventually. It's not a matter of whether, but when.

Some insights from investor Chanos.

Stiglitz at Davos

Joseph Stiglitz comments on Obama's economic policies at Davos, Switzerland.

State of the Union

Obama's State of the Union Address Wednesday night:

Fed exposed

The risk faced by the Fed. Investment banks are being deleveraged; but the Fed got leveraged up:

The Federal Reserve's blowout 2009 profit is no reason to cheer. Rather, it is a reminder of the dangers inherent in the extraordinary policies the central bank has pursued during the credit crunch.


Last year, the Fed earned $52.1 billion, with most of that income coming from interest-payments on bonds that it bought during the year to shore up the economy and credit markets.

Anyone with access to printing presses could have racked up similar gains. But the Fed's purchases leave it exposed. Its assets are 43 times its capital, compared with 15 times at Goldman Sachs. As a result, its equity could be wiped out by just a 2.8% drop in the value of its Treasurys and securities issued by Fannie Mae and Freddie Mac. True, the Fed could hold on to those securities and ride out any losses, and retain earnings to boost capital, but what self-respecting central bank wants to risk a negative net worth?

Even the fact that the Fed is, as usual, paying most of its profit to the Treasury isn't good news. It means the Treasury is paying almost no interest on a large slug of debt purchased by the Fed. That can only chip away further at fiscal discipline.

Wednesday, January 27, 2010

Early signs of 'double dip"

Housing prices turned down again. Be beware of double-dip.

(click to enlarge

Tuesday, January 26, 2010

What drives Euro?

Euro outlook from WSJ:

Be careful what you wish for. Six weeks ago, Jean-Claude Juncker, who chairs the group of euro-zone finance ministers known as the Eurogroup, complained that the euro was overvalued. Since then it has fallen 6.6% against the dollar. But Mr. Juncker can't be too happy. Persistent fears about Greece's fiscal situation have turned trade in the euro into a vote on the currency bloc's credibility.

The euro now trades just below $1.41, versus a peak on Nov. 25 last year of $1.51. Even that decline hasn't done much to erase the currency's strength, accumulated over much of the previous decade: in mid-December, at $1.45, the European Commission warned that the euro was overvalued on a real effective basis by 7% to 8%.


A range of factors are weighing on the euro. Some seem likely to be transitory: Fears about China's moves to rein in credit growth seem more aimed at trying to head off domestic inflation before it gets out of control, and thus should be good for global risk appetite in the long run. But others are more deeply entrenched. The European Central Bank has warned that the recovery in Europe will be gradual, and many expect the bank to increase rates later than the U.S. Federal Reserve or the Bank of England.

The key driver, however, has been the strains within the euro zone that Greece's struggle to rein in its public finances has brought into the spotlight. The euro's fall has come in lockstep with a rise in the cost of insuring Western European sovereign debt against default, as measured by the Markit iTraxx SovX index, which hit a record high of 0.84 percentage point points Wednesday, up from 0.57 at the start of December. Higher yields and a weaker currency might help to lure foreign buyers of bonds, something Greece is desperate to do. But higher yields are being interpreted as a sign of distress, rather than an opportunity. Hawkish ECB rhetoric warning that there will be no fudge on euro-zone rules to aid Greece are intensifying the pressure, even if his should be good for the euro's credibility in the longer term.

Further pressure seems likely as a result—at least in the short-term. Barclays technical analysts warn that a break below $1.4050 could lead to a dip as far as $1.3730; Citigroup said in January the euro could drop as far as $1.35. One worry now is contagion: If investors become concerned about other euro-zone countries such as Portugal, Spain or Ireland, more may decide to dump the single currency.

Existing home sales

Talking about double dip...imagine what it will look like when government's support is taken away.

Sales/inventory ratio shows we probably still have long way to go (esp. when you compare the current ratio with the average in the past decade):

(graph courtesy of Northern Trust)

Budget gap by state

(click to enlarge; source: CBO)

Saturday, January 23, 2010

Clash in the White House

Friday, January 22, 2010

Smart regulations

More regulation is not the solution; what we need is smart regulation. By this metric, Obama's proposal fell far short of it. The following piece is by far the most intelligent analysis I have seen.

From WSJ:

President Obama has acquired the sudden appetite for a fight to rein in Big Finance. But he needs something else even more: a coolheaded understanding of where the riskiness really lies in the banking sector.

In an impassioned speech Thursday, the president said he wants financial-overhaul legislation to include measures to stop banks engaging in proprietary trading and investing in hedge funds and private-equity ventures.

On the surface, that makes sense. After the financial trauma of recent years, something decisive had to be done to prevent banks putting the system at risk again through these kinds of activities. Bear Stearns's hedge funds helped spark the credit crisis. Banks have taken massive hits from real-estate investments made by their principal investment arms, including Goldman Sachs Group, whose losses in this area have totaled nearly $4 billion since the start of 2008. And who can forget the soured mortgage bet that helped trigger Morgan Stanley's $7 billion trading loss in the fourth quarter of 2007?

But two big questions hang over the president's push. First, will these moves address other activities that carry as much potential danger? Second, which firms will be affected?

On the first, the real headache lies in deciding how broadly to define proprietary trading. For instance, trading includes the process of amassing and managing inventories of securities and derivatives. Banks say most of that is to serve clients, but they also trade around those positions on their own balance sheets, creating a gray area. A further problem: Banks can take huge losses from asset inventories built up for other reasons. That happened to Merrill Lynch and Citigroup, with subprime mortgages being packaged into structured securities and leveraged loans they intended to sell on. Somewhere in the overhaul there also have to be regulations to protect balance sheets from potential risk-asset buildups that aren't straight proprietary trading positions.

And with big securities operations, the liability side of the balance sheet can't be ignored. Losses on assets can make a bank's creditors skittish, leading to a run. That is why Mr. Obama needs to back stringent changes to make market funding safer. Last week's bank-liability tax was one avenue, but he also needs to stop the foolhardy taxpayer-backstop for banks' market funding included in both the House and Senate bills.

On the second question, President Obama seemed to focus his speech on deposit-taking institutions with large securities businesses. Among one of the many areas left very unclear was what would happen to the likes of Goldman Sachs and Morgan Stanley, which could easily unload their small deposit-taking banks. Another big uncertainty is how rules would apply to securities subsidiaries of foreign firms, to avoid giving them an unfair advantage.

There is clearly a reasonable chance the seemingly-rushed-out plans get watered down or held up in Washington. But investors still need to think about who would get hit hardest if they occur. The big deposit-taking banks with large securities arms—Bank of America, J.P. Morgan Chase and Citi—could become far more heavily weighted toward traditional commercial banking. Net income at BofA's global-markets unit was $7.2 billion, versus $6.3 billion for the whole bank. J.P. Morgan's investment bank accounted for nearly 60% of overall earnings in 2009.

Meanwhile, it is unlikely that Goldman Sachs or Morgan Stanley call pull off a Houdini-like escape by unloading their deposits. If they do, regulators may choose to push similar restrictions through capital rules and other means instead.

Goldman acknowledges that about 10% of total revenue comes from pure proprietary trading.

As President Obama braces for a fight with the Big Finance, the banks have plenty of reason to take him on.

On Bank Bashing

Here are two opposite views from two of my favorite:

Stephen Roach, Chairman of Morgan Stanley Asia:

Bob Reich, former Labor Secretary under Clinton Administration, professor at Brandeis University and now at UC Berkeley.

Why Obama must take on Wall Street

"Volcker Rule": The New Glass-Steagall

Further analysis on the new rule on American banks.
More regulation is coming. That's for sure, after a big crisis.

(click to play)

China to launch foreign stock ETF

China has some innovative ways to diversify its huge foreign reserves. I am very happy to see China did not stop its reform in financial sectors in the aftermath of financial crisis, rather the pace has sped up.

The Shanghai Stock Exchange, in an effort to expand ties to overseas markets, will launch China's first exchange-traded fund tracking foreign stocks this year, SSE president Zhang Yujun said on Thursday. The announcement follows local media reports that the SSE will allow Chinese fund companies to develop global ETFs to track overseas indices such as the Dow Jones Industrial Average. It also comes amid expectations that Beijing will finally allow foreign companies to list in Shanghai this year.

Thursday, January 21, 2010

Household leverage and house prices

The higher the leverage ratio a country's household has, the higher increase of house prices; and when bubble bursts, the sharper the price decline.

I am very surprised to find out Denmark (the country I am currently living in) has the highest household leverage ratio. Faint!

The stage of irrational exuberance:

Days of Reckoning:

Read the full research at SF Fed

No more proprietary trading?

The White House wants commercial banks that take deposits from customers to be barred from investing on behalf of the bank itself—what's known as proprietary trading—and said the administration will seek new limits on the size and concentration of financial institutions.

"You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," the official said.

full text here.

Larry Summers on innovation economy

Larry Summers on the future of innovation, and what are the challenges faced by the US from China and India, and how the US should respond.

Innovation and Economic Growth from Innovation Economy on Vimeo.

FDI in 2009

FDI was down 57% to the US; but only down 2.6% in China.

(Click to enlarge)

Link to the article

Those investment fools

A reality check on long-term investing, from Jason Zweig:

What are we smoking, and when will we stop?

A nationwide survey last year found that investors expect the U.S. stock market to return an annual average of 13.7% over the next 10 years.

Robert Veres, editor of the Inside Information financial-planning newsletter, recently asked his subscribers to estimate long-term future stock returns after inflation, expenses and taxes, what I call a "net-net-net" return. Several dozen leading financial advisers responded. Although some didn't subtract taxes, the average answer was 6%. A few went as high as 9%.

We all should be so lucky. Historically, inflation has eaten away three percentage points of return a year. Investment expenses and taxes each have cut returns by roughly one to two percentage points a year. All told, those costs reduce annual returns by five to seven points.

So, in order to earn 6% for clients after inflation, fees and taxes, these financial planners will somehow have to pick investments that generate 11% or 13% a year before costs. Where will they find such huge gains? Since 1926, according to Ibbotson Associates, U.S. stocks have earned an annual average of 9.8%. Their long-term, net-net-net return is under 4%.

All other major assets earned even less. If, like most people, you mix in some bonds and cash, your net-net-net is likely to be more like 2%.

The faith in fancifully high returns isn't just a harmless fairy tale. It leads many people to save too little, in hopes that the markets will bail them out. It leaves others to chase hot performance that cannot last. The end result of fairy-tale expectations, whether you invest for yourself or with the help of a financial adviser, will be a huge shortfall in wealth late in life, and more years working rather than putting your feet up in retirement.

Even the biggest investors are too optimistic. David Salem is president of the Investment Fund for Foundations, which manages $8 billion for more than 700 nonprofits. Mr. Salem periodically asks trustees and investment officers of these charities to imagine they can swap all their assets in exchange for a contract that guarantees them a risk-free return for the next 50 years, while also satisfying their current spending needs. Then he asks them what minimal rate of return, after inflation and all fees, they would accept in such a swap.

In Mr. Salem's latest survey, the average response was 7.4%. One-sixth of his participants refused to swap for any return lower than 10%.

The first time Mr. Salem surveyed his group, in the fall of 2007, one person wanted 22%, a return that, over 50 years, would turn $100,000 into $2.1 billion.

Does that investor really think he can get 22% on his own? Apparently so, or he would have agreed to the swap at a lower rate.

I asked several investing experts what guaranteed net-net-net return they would accept to swap out their own assets. William Bernstein of Efficient Frontier Advisors would take 4%. Laurence Siegel, a consultant and former head of investment research at the Ford Foundation: 3%. John C. Bogle, founder of the Vanguard Group of mutual funds: 2.5%. Elroy Dimson of London Business School, an expert on the history of market returns: 0.5%.

Meanwhile, I asked Mr. Salem, who says he would swap at 5%, to see if he could get anyone on Wall Street to call his bluff. In exchange for a basket of 51% global stocks, 26% bonds, 13% cash and 5% each in commodities and real estate—much like a portfolio Mr. Salem oversees—the institutional trading desk at one major investment bank was willing to offer a guaranteed rate, after fees and inflation, of 1%.

All this suggests a useful reality check. If your financial planner says he can earn you 6% annually, net-net-net, tell him you'll take it, right now, upfront. In fact, tell him you'll take 5% and he can keep the difference. In exchange, you will sell him your entire portfolio at its current market value. You've just offered him the functional equivalent of what Wall Street calls a total-return swap.

Unless he's a fool or a crook, he probably will decline your offer. If he's honest, he should admit that he can't get sufficient returns to honor the swap.

So make him explain what rate he would be willing to pay if he actually had to execute a total return swap with you. That's the number you both should use to estimate the returns on your portfolio.

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Mass got a GOP

A Republican won a special election for Ted Kennedy’s old Senate seat in Massachusetts. Scott Brown’s victory, in a state that has not elected a Republican senator for Congress since 1972, was a huge upset for the Democrats and came after Barack Obama had thrown his full weight behind the Democratic candidate in an effort to get out the vote.

The Democratic defeat was widely interpreted as a repudiation by independent voters of many of Mr Obama’s policies, one day before the first anniversary of his inauguration. See article from Economist
and from NYT.

Tuesday, January 19, 2010

BYD to enter the US market

The electronic car made by Chinese firm BYD, which is invested by Warren Buffet, is scheduled to enter the US auto market second half of this year.  The car sells for $40,000...still too expensive.

Snapshot of China's Wind Power Industry

China is trying hard to restructure its domestic economy and in the process it may produce overcapacity in new areas if the infrastructure of delivering and using these alternative energy sources are not in place in time (reports WSJ):

Beijing has big plans for wind power as a renewable energy of the future, but China may already have too much of a good thing.

At home, China's power-transmission infrastructure can't handle the intermittent electricity supply already being generated from wind. It is estimated that 30% of last year's wind-power supply went unused.

Despite that bottleneck, Beijing wants more. The government hopes to see 100 gigawatts of wind-power capacity installed in China by 2020, a more-than-eightfold increase from 2008, making wind the third most important source of power in China behind coal and hydroelectric. Even by next year, the amount of wind-power equipment being made will be twice what the nation can install, according to the central government.

That has implications abroad. Foreign rivals are raising concerns that Chinese producers will export their excess capacity at cheap prices. Wind power was one of the industries cited last week by the European Chamber of Commerce in China as likely to stir trade tensions.

The Chinese companies have already proven to be formidable competitors. Domestic producers have seen their Chinese market share blossom to nearly 60% collectively. That's largely at the expense of foreign players like Vestas Wind Systems, Gamesa and General Electric, which were dominant there just five years ago.

Critics suggest an implicit "Buy China" policy has helped the domestic players, but it's clear, too, that they have competed strongly on price. Data from analysts IHS CERA show Chinese equipment suppliers sell their turbines for almost two-thirds of the price of foreign competitors.

Not surprisingly, the number of players in the wind-power equipment sector has mushroomed, drawn to the sector by talk of greater reliance on renewable energy. Four companies accounted for more than 90% of the wind-turbine-manufacturing market in 2004. Now, 12 industry leaders account for about the same proportion, according to IHS CERA. Around 70 smaller firms are also active.

As local players duke it out, consolidation is likely in the near term. That will likely benefit the domestic industry leaders: Sinovel Wind, Xinjiang Goldwind Science & Technology and Dongfang Electric.

All this is happening in a market that is already uncertain as governments debate climate-change initiatives. Potential problems have already marred a United Nations wind-power credit program, for example.

The world may want China to commit to a greener future, but it's rapidly finding out that the push can come with some unwanted side effects.

Four things to worry in 2010

Among those, what worries me most is bank's balance sheet.

Few would have dared predict 12 months ago that markets would rebound so strongly. Most major stock markets ended 2009 at or around their highs for the year. Both the S&P 500 and FTSE Eurotop 100 rallied 24% over the year, while corporate-bond markets and commodities also staged rallies.

But what about 2010? Most economists expect the recovery to be sustained, albeit with fewer opportunities, to make significant gains. But any optimism needs to be tempered by caution. The global economy still is exposed to significant risks. Here are four:

Sovereign risk: The Dubai World debt default and Greek fiscal crisis were reminders that vast amounts of debt remain outstanding, with implicit or explicit guarantees from friendly sovereign nations. Will those nations be willing to stand behind the debt? The market is betting Abu Dhabi will bail out Dubai and the euro zone won't allow any of its members to default, even if the pain spreads to other highly indebted states such as Ireland and Spain. A more-pressing case may be the U.K., whose fiscal position is the worst in the industrialized world and which enjoys no implicit guarantee.


Exit strategies: The Federal Reserve and European Central Bank both have set out plans to withdraw much of the emergency liquidity supplied during the crisis. The Bank of England also is expected to stop buying U.K. government bonds in February. That could pave the way for considerable bond-market volatility, because central-bank programs have helped push down yields across all asset classes. Investors should be wary of parallels with 1994, when an unexpected U.S. interest-rate increase triggered a bond-market rout. On that score, they should be watching for any sniff of rising inflation.

Slow growth: Much of the optimism in the markets is based on expectations that global growth will be robust enough to speed up the process of deleveraging among overindebted Western economies. One risk to this outlook is that a combination of fiscal tightening and monetary-policy exit strategies leads to a "double-dip" recession. Another is that U.S. unemployment will be slow to fall while European unemployment continues to rise, leading to weak consumer demand. A slower-than-expected recovery would lead to higher bank-loan impairments and put more pressure on government fiscal deficits.

Bank balance sheets: The global banking system is in better health than a year ago, bolstered by large injections of equity and strong earnings. But trading desks could be vulnerable to any asset-price corrections. And doubts remain whether banks are facing up to the full extent of losses on loan books. The practice of "amend, extend and pretend," particularly in relation to commercial property, may be concealing the true scale of bad debts. A sharp rise in bond-market yields also would put pressure on bank-funding costs.While 2010 is unlikely to bring anything like this year's gut-wrenching volatility, investors shouldn't expect it all to be plain sailing.