BANK FOR INTERNATIONAL SETTLEMENTS
2000 ANNUAL REPORT
A. External imbalances: this is the concerted effort to slow U.S. to strengthen Europe
no other way this can be done just as Asian Crisis transferred monies to Europe for Euro
This will also impact the value of the dollar (Summers favors strong dollar and Fed does not)==
B. Is the world, in general, over loaded in debt which makes the need to have balanced growth more important and to reign in the crowd mentality in the States?
C. What kind of kind of indicators and for how many months would suggest that the Fed does not have to increase rates again?
Address by Urban Backstrom, Chairman of the Board of Directors and President of the BIS
1. Discuss few of major risks to continued economic/financial stability
2. Every region of the world has seen an improvement in performance: Southeast Asia, Russia, Korea and Brazil have rebounded from recent crisis
3. U.S. economy is enjoying its longest ever recorded expansion which has made an important contribution to the strength of the global recovery.
4. Despite rise in oil prices, inflation is still subdued in U.S., Europe and other countries
5. The acceleration in global growth has refocused attention on inflationary pressureson sustaining monetary stability.
6. Process of monetary tightening began last year in the industrial countries. The U.S. and U.K. were the first to raise interest rates, followed by ECB.
7. Two major worries: EXTERNAL IMBALANCES AND HIGH ASSET PRICES in order to have a SOFT LANDING BY APPROPRIATE MONETARY POLICIES AND IMPLEMENTING FURTHER STRUCTURAL REFORMS.
8. EXTERNAL IMBALANCES - In order to adjust smoothly, growth in the U.S. needs to slow to a more sustainable rate, and growth elsewhere needs to continue to strengthen. This will also include stronger euro-yen and weaker dollar as well as change in growth in U.S. to Europe
What impacts external imbalances?
9. IMPRUDENT LENDING and HIGH ASSET PRICES might lead to complacency about debt levels. Rising levels of household and corporate indebtedness in the U.S. are based on expectations of continued strong growth in income and production
[Consumer debt now exceeds household mortgage debt. U.S. business
Debt and consumer debt exploded by almost $1 trillion last year while
Savings plunged into negative territory. The $70 trillion in derivatives
Assume constant liquidity and credit which does not exist.]
10. There is a need to have emerging market borrowers take out insurance against volatile capital flows, including longer debt maturity and arranging contingent lines of credit [IMF].
11. The BIS is working on these things through:
Committee on Global Financial Systems
Monitors potential [weaknesses] vulnerabilities in the financial system,
Examining practical ways to make it more stable
Committee on Payments and Settlements
Paper developing core principles for systematically improved payment systems
Basle Committee on Banking Supervision
Revamping the capital adequacy framework linking capital more closely to banks risk exposure
12. The prevailing external and internal financial imbalances obliges me to strike a cautionary note. For recovery to continue, governments must persevere with labor market and fiscal reforms, with privatization and deregulation, and with prudent budgetary policy.
13. NEED TO MAINTAIN PRICE STABILITY: [S&P at 30 times earnings; NASDAQ 100 at 150 times]
Financial times May27-28,2000 p. 6
The rule of thumb used to be that European investors would profit from new internet ideas six months after their US counterparts. But new Europe is experiencing a different US phenomenon: the dark moon that afflicted US technology in April is sweeping across the Atlantic. More than 60 US IPOs have been cancelled or postponed since the index peaked on March 10. In Europe, dozens of IPOs have fallen by the wayside. The mighty Nasdaq the once mighty standard-bearer of US investors' enthusiasm for technologywas down more than 36% in early trading on May 26. The UK Techmart 10p0 was down 48 % and Germany's Neuer Markt was off 39% from its March high. Richard Grasso, head of NYSE said, "[The decline] serves to remind investors in both arenas [Nasdaq and NYSE] that trees don't grow to the sky. If you look at the rate of return in the last five years and assume that is the rate of return going forward, you miss the point of the previous 95 years [when returns were much lower.]"
Between April 16 and August 21, 1999 the tech sector declined between 30 to 50% yet it was an extraordinary year. As a result, many investors in the technology sector are still sitting on handsome gains. The Nasdaq is still up more than 30% from a year ago.
FT 5/27-28,,2000, p. xxvii
The U.S. House voted to grant China permanent normal trading relations. The Senate which was a triumph for President Bill Clintonand for corporate America. The Senate is expected to confirm in June. It's a volatile market for technology stocks in Europe, and the casualties are mounting: day-traders become disillusioned; bankers watch their bonuses vanish, and companies abort planned public offerings. Over the past 3 months, about 20 European companies have postponed float plans because of market turbulence.
5/27-29/00 p. 24
Speculation that the ECB will prop up the euro by intervening in the markets gave the single currency a powerful shot in the arm yesterday, lifting it to its highest level against the dollar since last April. The euro bolted higher in late London trading, rallying by more than two cents to touch $.93333.
FT, Investors take flight when the bear shows legs as well as teeth, 5/30/00, p. 21
The message of last week's stock market was clearthis bear has legs. The 8 week old drubbing in the technology sector spread to financial firms with a vengence. Treading has turned lethal for the small investor.
FT, 5/29/00 , Greenspan gets to grips with his next Mission Impossible, Gerard Baker
Two years ago, the Fed moved swiftly to cut interest rates and shield the US from the worst storm. They not only kept the US expansion on track but helped lift the rest of the world quickly out of its emerging slump. Now the Fed is grappling with what is evidently a much harder task. To slow down the now frantic pace of US growth by just enough to keep the expansion on track without bring about a recession. In 1999,` they raised short-term interest rates six times or by 1.75%. But could there now be the first faint sings that the long-awaited slowdown is in the offing? With consumer spending at 4% and a slowdown in the housing market, a slowdown appears to be in the works.
1-800-610-9191 for 2 casettes for $16.99 - do whop
Financial Times 5/31
OECD looks to Fed for sharp rise in interest rates, p1 - Ed Crooks
The U.S. Federal Reserve must raise interest rates sharply to avoid a hard landing for the U.S. economy, according to OECD. If the Fed does not raise rates substantially by August, the OECD says, it could result in a sharp fall on Wall Street, a slump in the dollar and a global economic downturn.
Unless central banks act now to head off the threat of inflation, the OECD says, then interest rates will in the end have to rise even further which could cause a sharp slowdown in the world economy, accompanied by a "disorderly correction" in stock markets and a "loss of confidence in the dollar."
[Note: The NASDAQ had an up weekthe first in two months which was preceded by
a week long string of losses. The following occurred May 29 - June 2:
Monday: ? ; Tuesday 100 points? up; Wed: (50) points; Thurs up 182 points; Fri: up 225 to
Close at 3808, up 18.8% for the week]
US consumer confidence close to record high - Sathnam Sanghera p 6
US consumer confidence rose sharply in the month of May, approaching the record high reached in January, suggesting that volatile stock market conditions and interest rate increase have NOT YET BEGUN TO SLOW DOWN BUOYANT CONSUMER SPENDING. The strong comeback in consumer confidence goes against a number of indicators over the past month that have suggested that the spending growth that has powered the US expansion may be starting to ease.
--A slowdown in consumer spendingwhich accounts for 2/3's of all measured economy activityis central to the Fed's aim of easing the pace of growth, has been running at 8% through most of 1999 with the Fed raising interest rates six times to 1.75% in an effort to curb it.
Argus Research says it expects an extremely robust season of spending this summer it might be August before we see anything resembling a slowdown.
What the Fed will do is dependent on the purchasing managers report, retail sales, new home sales, jobs data, and durable goods.
Editorial: "Monetary policy and the Markets" p.12
OECD report provides a "salutary reminder that the financial markets still have the capacity to unbalance global growth. The OECD is worried that unless preventative action is taken by central banks, a wave of optimism could result in a dangerous runaway boom. The task of managing the upswing has been made more difficult by the behavior of financial markets. Generally central banks have little trouble responding to conventional economic pressures like tight labor markets But asset prices, such as share prices or exchange rates, are largely unpredictable and uncontrollable, and so much harder to factor into interest rate decisions. As the impact of financial markets on the world economy grows, the task of the central bankers become harder.
Exchange rate movements (OECD) have made a mixed contribution toward re-balancing global demand.
The yen has not appreciated since early 1999
The sterling's strength helped to control the UK economy and the weakness of euro was helpful at first but its recent depreciation may put price stability at risk in the future.
CRITICAL TO GLOBAL GROWTH IN THE FUTURE WILL BE THE RELATIONSHIP BETWEEN THE DOLLAR NAD THE EURO. THE HUGE U.S. EXTERNAL DEFICIT MEANS THAT SHOULD INVESTORS LOSE CONFIDENCE, A DRYING UP OF CAPITAL INFLOWS COULD LEAD TO A LARGE FALL IN THE DOLLAR. IF THE FED FAILS TO SLOW THE ECONOMY SUFFICIENTLY, THE MARKETS ARE SURE TO BRING IT TO A LESS COMFORTABLE HALT.
Washington Post, 6/2/00, E1, John Berry
Leading U.S. economists state that two months of flat retail sales, and a combination of falling auto sales and weak chain store sales, "means a weak retail sales number for May as well."
WP,6/2/00, E1, "the Derivatives Dilemma" by Kathleen Day
In the $5T derivatives market, traders face the situation that they may not be enforceable in court. OTC derivatives are financial contracts whose worth is based on the value of underlying stocks/bonds, interest rates, currencies or other commodities. They are used to hedge against the risk of price fluctuations or to speculate. They have grown fivefold during the past decade and are now a key risk management tool for nearly every business from automakers wanting to pin down future borrowing costs to banks wanting to minimize losses from interest-rate changes.
The legal status of OTC derivatives is murky The enforce-ability of these contracts has never been tested in court. Regulators and industry executives hope it stays that way until Congress clears up the laws governing these complex financial products. Until Congress acts, however, industry executives and federal regulators live with the nagging worry that severe market turmoil might cause someone on the losing end of an OTC derivative contract to walk away from it. Summers and Greenspan have been urging Congress to settle the question before it ever gets to courtor spooks investors. "The legal uncertainties create risks...to our financial system that are simply unacceptable" said Greenspan. However, Congress has been paralyzed by disagreement within the securities industry. For years there has been a turf battle between the SEC and the Commodity Futures Trading Commission (William Rainer) to settle their differences.
The potential gravity of allowing the issue to twist unresolved was underscored 18 months ago with the near collapse of Long-Term Capital management LP which relied heavily on OTC derivatives to speculate. Regulators so feared that the fund's woes would unravel securities markets that the Federal Reserve Board orchestrated a $3.6 billion bailout of the fund by its 14 largest lenders.
OTC derivatives has grown 400% from a decade ago, 50% from five years ago and today is valued at over $80 trillion when measured by the value of the underlying goods from which they derive their value or about $5 trillion when the actual money at risk is totaled. The OCT derivatives market is dominated by J. P. Morgan, Citigroup, Chase Manhattan, and Merrill Lynch.
CONGRESS MUST RE-AUTHORIZE THE CFTC BY THE END OF SEPTEMBER. INDUSTRY AND FEDERAL FINANCIAL REGULATORS HOPE LAWMAKERS WILL USE THE OPPORTUNITY TO ADDRESS THE OTC DERIVATIVES QUESTION. If not, "it may take a very major event to get closure on this issue."
International Herald Tribune - June 3-4
The NASDAQ surged 18.8% for the week ending June 2; S&P up 7.3% and Dow up 4,6%. The talk is the Nasdaq closing above 4000 which was April 11 and was in the middle of a five day, 25% slide. The index is still down 6.4% for the year and is 24.5% off its record high set March 10 of 5048. Wall Street is betting that there will not be another rate hike.
WSJ, Europe - June 5 2000 - p1 "Fed Rate Increases Begin to Rein in runaway Economy, John D. McKinnon, Yochi J. Dreazen and Nicholas Kulish
In his bid to bring the U.S. economy in for a "soft landing" Fed Reserve Chairman Greenspan at least has the landing gear down. The six interest-rate increases engineered by the Fed since last June are beginning to cool off interest-sensitive sectors such as housing/construction. All of this is good news for the beleagured euro which has begun to gain some ground against the dollar after hitting a low of 88.45 cents last month. Still the signals being put out by the U.S. economy remain hazy. Friday's jobless rate increased to 4.1% last month from 3.% in April.
At the Fed, a continued concern is that financial markets may soar on the belief that the Fed's business is done and that as a result, it may not be. Chairman Greenspan has spoken at length in recent monthsbv about how strong financial markets fuel demand in the economy and make it necessary for the central banks to raise rates. So if the market rates rises sharply, rates may have to rise more as well. "The irony is that because the markets must trust Greenspan so much, he'll have to do more" in the way of tightening to protect the economy from the ill effects of overreaching equity markets," says Bill Dudley an economist at Goldman Sachs in New York.
Business loans are down 25% as an indicator of tightening.
For now the decline in technology stocks since the first of the year seem to be one more factor contributing to an overall slowing of the economy. For now the decline in technology stocks since the first of the year seems to be one more factor contributing to an overall slowing of the economy. With Web companies of all sizes and stripes getting a painful reminder that profits still matter, many are resorting to a tactic unthinkable in the rapidly expanding sphere : layoffs. Amazon.com have dismissed workers for the first time in their history.
June 6, 2000, Dow weakens but techs hld steady, FT
Wall Street opened another mixed session with technology stocks mostly treading water while blue chips sagged. Nasdaq at 3852.
Cheers in euro-zone as economic growth hits home 6/7/00, 2
A fall in unemployment and a rise in consumer confidence to a record high provided fresh evidence yesterday that economic growth is firmly established in the euro-zone. Coupled with expectations that the ECB will raise interest rates today, the data helped lift the euro to a 7 week high against the dollar on foreign exchange markets. With the euro trading at .9550-, seven cents above its record low of .8845, some analysts see a diminishing possibility of direct ECB market intervention in support of the currency.
FT, 6/8/00, 11, Fed keen to curb speculation (Basle Core Principles)
Having freed up US banks to expand into new areas and set up private equity subsidiaries last year the US authorities are now seeking ways to rein in what they fear may be high risk speculative investment activities The US authorities, concerned about banks building up excessive risks are proposing to introduce new legislation to govern US banks' private equity investments. Any attempt to limit private equity investment which has become an important element of investment banks' revenues, could severely affect share prices say legislation. The new legislation, proposed in March by the Fed Reserve and the US Treasury follows on the Gramm-Leach-Bililey Act. But the new regulations put forward in march by the Fed and US Treasury propose to threaten those subsidiaries' capital requirement lending. Banks could be required to set aside capital worth 50% of their private eqauity investments to reflect the higher risk associated with such activities.
FT, 6/7/00, Banks move towards online currency trading
Seven of the world's lending foreign exchange banks yesterday took the biggest sep to date towards moving currency trading online. Fxall.com will host foreign exchange services from its founding members: BOA, Credit Suisse, First Boston; Goldman Sachs, HSBC, J.P. Morgan, Morgan Stanley Dean Witter, and UBS Warburg. The new system will be operational by the end of the year.
*****FT, 6/7/00, 17, Careful does it, Mr. Greenspan, Martin Wolf (use picture in newsletter)
In its latest report, the BIS warns of "many of the imbalances and structural deficiencies which had characterized the global economy in the previous few years came no closer to being redressed. Indeed in some respect the worsened. Foremost among these imbalances was the record high rate of private savings in Japan and the record low in the U.S." The latest Economic Outlook from the OECD suggests not. The economies of the OECD area are forecast to grow by 4% in 200 and 3.1% in 2001. This includes a smooth rebalancing of growth among the three principal OECD economies: the U.S., Japan and the EU. Behind the surge in US domestic demand lies a massive swing into deficit of the net financial balance of the private sector, itself influenced by the rise in the stock market.
Behind the surge in US domestic demand lies a massive swing into deficit of the net financial balance of the private sector, itself influenced by the rise in the stock market. This has been offset
by the improvements in the balance of the public sector. The BIS argues that "the rate of expansion of domestic demand in the US is unsustainable and potentially inflationary" and so indeed it is. It has also created a current account deficit that is itself unsustainable in the long run. Already US net external liabilities have risen from rough balance in 1988 to $1.9B in 1999 (20% of GDP). This explains why the Fed is tryind to reduce the growth in the US domestic demand below that of potential supply. Provided the Fed moves in its mysterious ways, the rest of the world should have little difficulty in accommodating the resulting modest external adjustment. But if demand were to weaken too fast or the dollar were to plunge or if BOTH WERE TO HAPPEN AT THE SAME TIMEthe external adjustment would be bigger and more painful.
The US and Japan have in effect become an odd couple, both dependent on the unsustainable behavior of the other. The US needs excessive Japanese savings just as Japan need excess US demand.
FT, 6/8/00, 13, Euro takes faltering steps to recovery, 1
In order to reinforce the euro, the 17 member board is expected to reinforce their message on the importance of monetary stability by making a .25% point rise in interest rates, the ECB's fifth increase since November. The euro remains considerably undervalued against the dollar, yen and sterling and is 18% below its launch rate in January 1999. With only 18 months to go before the euro replaces national banknotes and coins in 12 European countries, the revival has come at a crucial time for political leaders worried about the impact of the euro's weaknesses on the process of European integration. If market perceptions have since turned around, this no doubt owes much to the increasingly wide held view that US economic growth may be slowing down and that the Fed will stop raising US interest rates. The more euro-zone growth catches up with that of the US and the narrower the interest ate differentials between the two areas, the better the chances for euro-recovery.
FT, 6/9/2000, 14, Encouraging signs, Gerard Baker
Since June 1999 the Fed has raised interest rate six times. Manufacturing activity dropped for the 3rd straight month in May, the N'l Assoc Purch. Management reported: home sales fell markedly in April, the unemployment rate rose 4.1% in May from April's 3.9%. Stock prices have rebounded sharply from their slump of the early spring and bond prices have also risen. "The equilibrium real interest rate has gone up along with the increase in the economy's underlying potential rate of growth", says Jack Beebe, chief economist at the San Francisco Fed. With inflation at 4%, the equilibrium rate should be between 6.25 to 6.5%.
FT, 6/9/2000, Euro falls after surprise rate decision
The euro had a bumpy ride on the foreign exchange markets as they decided whether a surprisingly aggressive rate rise was good or bad for the currency. The euro initially bolted to almost a cent higher. With rates playing a central role in recent currency movements, many market observers expected the move to be sustained. The euro's negative reaction to the ECB rate hike elicited several competing explanations among analysts. The euro quickly tumbled lower giving up all of its post rate rise gains and more.
Ft, 6/9/2000, ECB surprises with « point rise
the ECB surprised financial markets when it raised interest rates by a larger than expected «%. Citing a risk that inflation would breach the ECB's 2% target this year and next, the bank raised its main lending rate to 4.25% from 3.75%. Duisenberg indicated that more increases were possible this year since even the latest tightening might not have restored monetary conditions to a neutral level. Duisenberg stated, "Not knowing what the neural rate is, I can't answer the question if we are still accommodative. I think we are."
USA Today, June 9, 2000 , 38 - Steady nerves needed for Europe investors, John Waggoner
The investment history of Europe for US investors had been tinged with tragedy. When the Berlin Wall fell in November 1989, U.S. investors rushed to invest in Germany. Mutual funds that invest in European stocks fared well, at lest until investors discovered what a mess East Germany was in. Since the fall of the Berlin Wall, the average European fund has risen 210% vs. 441% for S&P's 500 stock index. So what are the current arguments for investing in Europe? (1) the European economy seems to be growing at a reasonable rate (2) the euro's disappointment may be over, (3) Europe is restructuring through merges and acquisitions
This year the number of journalists are greatly reducedthe first year I was here there were about double the amount. I spoke to one young reporter who was at the annual meeting for the first time and he was talking about how boring it all was and how the press briefing was a "great bore." I told himhow can you say that when this is the most important meeting in the world?
p. 144 "were monetary policy to back off at the first signs of declining equity prices, the risks of moral hazard would be great. In any event, if we really have entered a 'new era', the likelihood of a sharp and sustained reaction in equity markets would be much reduced. And if we have not, then it could be argued that the sooner the bubble deflates, the better....Given recent low rates of saving and heavy investment in housing and durable goods, it wold be very easy to postpone prospective expenditures..... "
NOTE: BANKS ONLY PAY THE MINIMUM AND THEREFORE, PEOPLE ARE NOT LONGER SAVING THROUGH THE BANK BUT ARE SAVING IN THE STOCK MARKET IN ORDER TO OBTAIN A BETTER RETURN. IF THE FED WANTS TO HELP RETURN MONIES TO THE BANKS, THEN BANKS NEED TO PAY A HIGHER SAVINGS RATE. THEREFORE, IS THE LOW SAVINGS RATE PLANNED IN ORDER TO LURE PEOPLE TO THE STOCK MARKET??? SO THAT AMERICA HAS EXACERBATED PROBLEMS?