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  • Nouriel Roubini's Top Six Risks for Global Markets

    At Project Syndicate , Nouriel Roubini writes that the major risks to global markets have shifted. The leading risks from the last two years, while not quite resolved, are not as predominant. But there is plenty to be concerned about. Namely: For starters, there is the risk of a hard landing in China. The rebalancing of growth away from fixed investment and toward private consumption is occurring too slowly, because every time annual GDP growth slows toward 7%, the authorities panic and double down on another round of credit-fueled capital investment. This then leads to more bad assets and non-performing loans, more excessive investment in real estate, infrastructure, and industrial capacity, and more public and private debt. By next year, there may be no road left down which to kick the can. There is also the risk of policy mistakes by the US Federal Reserve as it exits monetary easing. Last year, the Fed’s mere announcement that it would gradually wind down its monthly purchases of long-term financial assets triggered a “taper” tantrum in global financial markets and emerging markets. This year, tapering is priced in, but uncertainty about the timing and speed of the Fed’s efforts to normalize policy interest rates is creating volatility. Some investors and governments now worry that the Fed may raise rates too soon and too fast, causing economic and financial shockwaves. Third, the Fed may actually exit zero rates too late and too slowly (its current plan would normalize rates to 4% only by 2018), thus causing another asset-price boom – and an eventual bust. Indeed, unconventional monetary policies in the US and other advanced economies have already led to massive asset-price reflation, which in due course could cause bubbles in real estate, credit, and equity markets. Fourth, the crises in some fragile emerging markets may worsen. Emerging markets are facing headwinds (owing to a fall in commodity prices and the risks associated with China’s structural transformation and the Fed’s monetary-policy shift) at a time when their own macroeconomic policies are still too loose and the lack of structural reforms has undermined potential growth. Moreover many of these emerging markets face political and electoral risks. Fifth, there is a serious risk that the current conflict in Ukraine will lead to Cold War II – and possibly even a hot war if Russia invades the east of the country. The economic consequences of such an outcome – owing to its impact on energy supplies and investment flows, in addition to the destruction of lives and physical capital – would be immense. Finally, there is a similar risk that Asia’s terrestrial and maritime territorial disagreements (starting with the disputes between China and Japan) could escalate into outright military conflict. Such geopolitical risks – were they to materialize – would have a systemic economic and financial impact. Read The Changing Face of Global Risk here .
  • The Challenge Ahead for Commodity-Price Dependent Latin American Economies

    Andrés Velasco , former finance minister of Chile, is not exactly bullish on growth in his country and across the region. At Project Syndicate , he lays out the challenge ahead. If Latin American economies do not diversify sufficiently, then maintaining anything close to the recent rate of growth will be difficult. Velasco: It is pretty clear by now that an extraordinarily benevolent external environment, not a revolutionary policy shift, underpinned Latin America’s rapid growth in the years following the 2008-2009 global economic crisis. As long as the price of soy, wheat, copper, oil, and other raw materials remained stratospheric, commodity-rich countries like Brazil, Chile, and Peru got a tremendous boost; even Argentina grew rapidly, despite terrible economic policies. But now “secular stagnation” – the concept du jour in US policy debates since former Treasury Secretary Larry Summers argued last November that the US (and perhaps other advanced economies) has entered a long period of anemic GDP growth – may also be coming to Latin America. The argument goes like this: high consumer debt, slowing population growth, and rising income inequality have weakened consumer demand and stimulated savings, while slowing growth in productivity and output itself has discouraged investment. So the “natural” rate of interest – the rate at which the demand for investment equals the supply of savings – has fallen, and arguably has become negative. But, because real interest rates cannot be strongly negative unless inflation is high (which it is not), there is a savings glut. With consumption and investment lagging, the US economy is bound to stagnate. But how could such a situation apply to Latin America, where GDP growth is faster, interest rates are higher, and domestic demand is stronger than in the US? Consider the region’s history. Until the recent commodity-driven boomlet, growth in Latin America was mediocre. The 1980’s are known as the “lost decade,” owing to a debt crisis and massive recessions, while the market-based reforms of the 1990’s did little to reignite short-run growth. From 1960 to 2007, only four countries in Latin America and the Caribbean – Brazil, Chile, the Dominican Republic, and Panama – grew faster than the US. So meager growth in the coming years would be a return to Latin America’s historical pattern, not a deviation from it. Read Secular Stagnation Heads South here .
  • McKinsey Quarterly: Understanding the 'Full Supply Circle'

    With increasing demand for resources and raw materials, variable costs for manufacturing are rising as a percentage of overall costs, according to a new report from McKinsey & Co . One Chinese steel company has seen its variable costs grow to make up 90% of overall costs, according to McKinsey researchers. This places a premium on companies being able to find new ways routes to supplies. For many manufacturers this should mean launching "resource-productivity initiatives," like energy saving and re-use and recycling plans. McKinsey researchers have put together an infographic to show the need to reconsider the traditional supply-chain model: Companies should first focus on activities within their operations, where they can exercise the most control; they can turn their attention later to activities that require the cooperation of other organizations, customers, or other stakeholders. Specifically, companies should prioritize the activities that offer the greatest potential for impact given their position on the production circle. Upstream manufacturers. Companies that are focused primarily on transforming materials into inputs used by other companies should start by optimizing production for resource productivity. Such companies have the most to gain by reducing the amount of material or energy they use in production. Indeed, the operations of mining companies are often as much as 10 times more energy intensive than the operations of companies that use their products. As a second step, manufacturers should prioritize waste recovery, which can enable them to secure access to materials through activities such as recycling and reuse. Downstream manufacturers. Companies focused primarily on making components or final products should start by optimizing their products in order to use materials more efficiently. These companies will gain most by designing products to reduce material requirements, minimize energy consumed while using them, and ensure they are optimized to be recycled or reused at the end of their life cycle. Downstream companies can also benefit from reducing the energy required to manufacture their products, but this may be a second priority, since the operations of downstream players are not as energy intensive as those of upstream players. Waste-management companies. Companies that handle waste materials—including those that collect, process, and manage waste—should start by optimizing processes and developing new markets for material reuse. They should develop the sorting and collection technologies and capabilities necessary to mine the highest-value materials from the general waste stream at the lowest possible cost. They should also develop business models to help other companies with their material-sourcing and reuse strategies. You can access the full infographic here , and read the full article here .
  • NYT: Price Controls and Food Shortages in Chavez's Venezuela

    Greg Mankiw points us to William Neuman 's article on Venezuelan food shortages in the New York Times . Mankiw writes that the article presents a strong case study for the impact of price controls, and maybe even the unforeseen results of a government's economic policy. Neuman: Venezuela is one of the world’s top oil producers at a time of soaring energy prices , yet shortages of staples like milk, meat and toilet paper are a chronic part of life here, often turning grocery shopping into a hit or miss proposition. Some residents arrange their calendars around the once-a-week deliveries made to government-subsidized stores like this one, lining up before dawn to buy a single frozen chicken before the stock runs out. Or a couple of bags of flour. Or a bottle of cooking oil. The shortages affect both the poor and the well-off, in surprising ways. A supermarket in the upscale La Castellana neighborhood recently had plenty of chicken and cheese — even quail eggs — but not a single roll of toilet paper. Only a few bags of coffee remained on a bottom shelf. Asked where a shopper could get milk on a day when that, too, was out of stock, a manager said with sarcasm, “At Chávez’s house.” At the heart of the debate is President Hugo Chávez ’s socialist-inspired government, which imposes strict price controls that are intended to make a range of foods and other goods more affordable for the poor. They are often the very products that are the hardest to find. Read With Venezuelan Food Shortages, Some Blame Price Controls here .
  • Impact of Oil Prices on Gas Prices: or What drivers can expect to pay at the pump

    With Iran cutting off its oil from Britain and France, oil prices have climbed to a nine-month high this week . So what will the impact be on gas prices here in the US? The answer may not be quite as simple as "gas prices rise when oil prices rise," says Econbrowser 's James Hamilton . There's speculation involved, and the price fluctuations do not always follow as we expect: Here's a closer look at the data over the last year. Average U.S. gasoline prices fell more than you would have predicted based on the Brent price. They have since come back up. But Brent has surged another $10/barrel over the last two weeks, and gasoline prices have yet to catch up to that latest move. Based on the historical relation, we might expect to see the average U.S. gasoline price rise from its current $3.59/gallon up to $3.84. One factor that's been driving Brent and WTI up over the last few weeks has been rising tensions with Iran. But why should threats or fears alone affect the price we pay here and now? Phil Flynn, a senior market analyst at PFGBest Research in Chicago, offered this interpretation: We're seeing panic buying in Europe and Asia because they're absolutely convinced that they're not going to be able to buy Iranian oil or there's going to be some kind of conflict that disrupts the transport of oil through the Strait of Hormuz.... there is a lot of hoarding in case the worst-case scenario happens. Asian buyers have been buying up West African crude like it's going out of style. Does it make sense for consumers to suffer now just because of something that may or may not happen in the future? If there are significant disruptions, the answer will turn out to be yes. We'll be glad that we used a little less today, and left a little more in storage, to help us better cope with the huge challenges we'll be facing in a few months. If the answer turns out to be no, then this is all just a lot of pain for nothing. Read Crude oil and gasoline prices here . Also see Oil Prices and Consumer Spending from the Richmond Fed .
  • Winning the 'Resource Prize' in an Age of Rising Commodity Prices

    In a new report at the McKinsey Quarterly , McKinsey analysts Richard Dobbs , Jeremy Oppenheim , and Fraser Thompson point out that we are in the midst of an historic expansion of middle class consumers globally. They estimate the global middle class will reach 5 billion people by 2030, with China and India leading that growth. This has brought on a significant challenge for economies and for global business: resource costs. While the economic growth of the 20th century was aided by "cheaper natural resources," commodity prices have been high for the start of this century, and are likely to remain so. Dobbs, Oppenheim, and Thompson argue that this problem represents an opportunity to companies that are willing and able to lead a "resource revolution," and take measures to adapt. The chart below shows their estimates of how much value companies can find in adjusting strategies to account for rising costs. They call this the "resource prize": The authors write that the key is to "create cost advantages" and "generate new stresses on the management of risk and regulation" by pursuing the following: Pursue growth opportunities. Helping consumers and companies to use or access resources more efficiently should be very good business in the years ahead. For instance, the fastest-selling elevator line in Otis’s 150-year history is the Gen2, which uses up to 75 percent less energy than conventional elevators. Major companies, such as General Electric and Siemens, are building resource productivity businesses by investing heavily in emerging clean-energy and clean-water opportunities ranging from wind turbines to industrial-energy efficiency. And in technology centers such as Silicon Valley, a broad range of clean-tech investors and entrepreneurs seek profits by revolutionizing resource productivity. In fact, venture capitalist Vinod Khosla predicted in a recent paper that positive “Black Swans” will “completely upend assumptions in oil, electricity, materials, storage, agriculture, and the like.” Boost internal efficiency. Companies have large, profitable opportunities to improve the efficiency of their resource use across the value chain. Consumer-packaged-goods manufacturers have cut their energy costs by up to 50 percent by pulling productivity levers that pay back their costs in less than three years. Wal-Mart Stores has implemented a sourcing strategy that aims to reduce supplier packaging from 2008 levels by 5 percent no later than 2013, for estimated direct savings of $3.4 billion.7 Capturing many of these supply chain opportunities will require much closer collaboration between upstream and downstream players. Manage risk. As resource inputs to production processes become increasingly scarce, companies need to develop a more sophisticated understanding of their exposure to different natural resources, including supply chain dependencies and regulatory risks. Steel, for example, is becoming ever more critical in the oil-and-gas sector because of the shift to offshore deepwater drilling. Steel production depends crucially on the supply of iron ore, which in turn relies heavily on the water used to extract it. Almost 40 percent of iron ore mines are in areas with moderate to high water scarcity, and a lot of steel is produced in places where water is relatively scarce. Read Mobilizing for a resource revolution here .
  • McKinsey Global Institute Report: Commodity Prices to Remain High and Volatile

    For the better part of thirty years, commodity prices kept going down. But that trend was reversed, in a big way, after 2000. Here's a look at McKinsey Global Institute 's commodity price index trend: Will this trend continue, subjecting us to higher and higher prices in the near future? McKinsey Global Institute analysts Richard Dobbs , Jeremy Oppenheim , and Fraser Thompson warn that prices will be volatile over the next two decades: Demand for energy, food, metals, and water should rise inexorably as three billion new middle-class consumers emerge in the next two decades.1 The global car fleet, for example, is expected almost to double, to 1.7 billion, by 2030. In India, we expect calorie intake per person to rise by 20 percent during that period, while per capita meat consumption in China could increase by 60 percent, to 80 kilograms (176 pounds) a year. Demand for urban infrastructure also will soar. China, for example, could annually add floor space totaling 2.5 times the entire residential and commercial square footage of the city of Chicago, while India could add floor space equal to another Chicago every year. Such dramatic growth in demand for commodities actually isn’t unusual. Similar factors were at play throughout the 20th century as the planet’s population tripled and demand for various resources jumped anywhere from 600 to 2,000 percent. Had supply remained constant, commodity prices would have soared. Yet dramatic improvements in exploration, extraction, and cultivation techniques kept supply ahead of ever-increasing global needs, cutting the real price of an equally weighted index of key commodities by almost half. This ability to access progressively cheaper resources underpinned a 20-fold expansion of the world economy. Read A new era for commodities here .
  • The IMF Growth Tracker Showing Moderating Growth Across Global Economy

    The IMF's World Economic Outlook shows a worrying global economic slowdown, led by Europe and the US. Among the many causes cited for slowing economic activity is the lack of demand in the private sector. The IMF's researchers suggest that they expected a quicker "handover from public to private demand." The tsunami and earthquake damage in Japan also bears some of the blame, as do disruption in oil supplies in North Africa this year. A lasting, and troubling factor is the lack of confidence on the part of consumers and businesses in developed economies of the West. The ripple effects of the dip in confidence are being felt around the globe. Note the impact on growth, as shown in the IMF's Growth Tracker : From the report: Worryingly, various consumer and business confidence indicators in advanced economies have retreated sharply, rather than strengthened as might have been expected in the presence of mostly temporary shocks that are unwinding. Accordingly, the IMF’s Growth Tracker (Figure 1.4, top panel) points to low growth over the near term. WEO projections assume that policymakers keep their commitments and the financial turmoil does not run beyond their control, allowing confidence to return as conditions stabilize. The return to stronger activity in advanced economies will then be delayed rather than derailed by the turmoil. Read the World Economic Outlook, and watch video of the IMF staff discussing their findings, here .
  • Bernanke on the Outlook for Growth and Inflation

    Federal Reserve Chairman Ben Bernanke also took to the podium yesterday, albeit with a much, much smaller audience. He gave his outlook on the US Economy in Minneapolis, but he there was little in his speech to suggest any significant change in monetary policy. He did address increased gas and food prices in the context of inflation concerns: Prices of many commodities, notably oil, increased sharply earlier this year. Higher gasoline and food prices translated directly into increased inflation for consumers, and in some cases producers of other goods and services were able to pass through their higher costs to their customers as well. In addition, the global supply disruptions associated with the disaster in Japan put upward pressure on motor vehicle prices. As a result of these influences, inflation picked up significantly; over the first half of this year, the price index for personal consumption expenditures rose at an annual rate of about 3-1/2 percent, compared with an average of less than 1-1/2 percent over the preceding two years. However, inflation is expected to moderate in the coming quarters as these transitory influences wane. In particular, the prices of oil and many other commodities have either leveled off or have come down from their highs. Meanwhile, the step-up in automobile production should reduce pressure on car prices. Importantly, we see little indication that the higher rate of inflation experienced so far this year has become ingrained in the economy. Longer-term inflation expectations have remained stable according to the indicators we monitor, such as the measure of households' longer-term expectations from the Thompson Reuters/University of Michigan survey, the 10-year inflation projections of professional forecasters, and the five-year-forward measure of inflation compensation derived from yields of inflation-protected Treasury securities. In addition to the stability of longer-term inflation expectations, the substantial amount of resource slack that exists in U.S. labor and product markets should continue to have a moderating influence on inflationary pressures. Notably, because of ongoing weakness in labor demand over the course of the recovery, nominal wage increases have been roughly offset by productivity gains, leaving the level of unit labor costs close to where it had stood at the onset of the recession. Given the large share of labor costs in the production costs of most firms, subdued unit labor costs should be an important restraining influence on inflation. Read Bernanke's speech here .
  • SF Fed Economic Letter: Impact of Energy Costs on Consumers' Inflation Expectations

    The latest Thomson Reuters/University of Michigan consumer survey shows that American households are becoming more wary of inflation. While the survey showed consumers' anticipating 3% inflation back in December, now they are expecting inflation to average 4.5%. Bharat Trehan , a research advisor at the Federal Reserve Bank of San Francisco , warns us not to put too much stock in this forecast (largely because of how energy prices affect inflation expectations). He shares the following graph in an Economic Letter for the San Francisco Fed: Trehan explains: Figure 2 shows the results of a regression, a statistical exercise that allows us to estimate how much attention consumers pay to recent core and noncore inflation in setting their inflation expectations for the year ahead. Importantly, the statistical procedure allows for the possibility that the amount of attention consumers pay to either measure of inflation can vary over time. The black line in the top panel of Figure 2 plots the estimated response of household inflation expectations to recent core inflation. To take one example, the estimate for the fourth quarter of 2000 shows that, if recent core inflation had been one percentage point higher than it was, households would have expected 0.4 percentage point more inflation over 2001. As the figure indicates, the estimated response of consumer expectations to core inflation was unchanged for much of the subsequent decade, though it did rise a bit in 2007 and 2008. Perhaps more noticeable is the decline since 2008, which brought the black line to about 0.1 by the first quarter of 2011, the end of our sample. The two blue lines are error bands that provide a measure of the uncertainty around the estimated response. Two-thirds of the time, the true response should lie between the blue lines. The lower blue line fell below zero beginning in 2010. Once the lower blue line falls below zero, statistically speaking we can no longer distinguish the estimated response from zero. In other words, we can no longer be sure that households are paying attention to the core inflation rate when forming inflation expectations. The bottom panel of Figure 2 presents the relationship between household inflation expectations and noncore inflation. Household response to noncore inflation seems more variable than household response to core inflation. It is high at the beginning of the sample and falls toward the middle. In the past few years, household expectations seem to have become more sensitive to noncore inflation-at about the same time that household sensitivity to core inflation has gone down. Read Household Inflation Expectations and the Price of Oil:
It's Déjà Vu All Over Again here .
  • SF Fed President: Inflation Will Peak in Middle of 2011

    Commodity prices have been rising, and this has raised some concern about rising inflation across the board. Speaking last week in Los Angeles, John C. Williams , CEO of the Federal Reserve Bank of San Francisco , gave his prognosis on inflation. In short, he expects inflation to peak in the coming months, and then "return to an annual level of about 1¼ to 1½%." Williams: There are several reasons for thinking the inflation bulge will be short-lived. First, commodity prices are not likely to keep increasing indefinitely at a rapid rate. Indeed, in recent weeks, prices for a number of commodities, including sugar and cotton, have fallen sharply. In addition, the prices of contracts for certain key commodities in the futures markets, such as crude oil, indicate that traders believe these prices won’t keep rising at double-digit rates. For example, the numerous supply disruptions that have pushed up prices of some foodstuffs, such as poor harvests in Russia and China, are not likely to be repeated. So even if commodity prices remain elevated, they won’t keep pushing up inflation. A second reason for believing that inflation will peak and then trend down is that higher commodity prices generally represent only a small proportion of the cost of the finished goods American consumers buy. For example, corn and sugar make up only a fraction of the cost of a box of Frosted Flakes. Most of the cost comes from the labor involved in manufacturing, distributing, and selling the breakfast cereal, including paying for air time for Tony the Tiger. This means that large percentage increases in commodity prices typically translate into relatively small percentage increases in consumer prices. Of course, some goods, such as gasoline, have very high commodity input shares. But, in today’s economy, these are more the exception than the rule. The stability of longer-term inflation expectations is a third factor that leads me to expect that inflation will start to ease later this year. It’s true that surveys show that consumers expect moderately high inflation over the next year. Households see gasoline prices going up and up and up, and, not surprisingly, they get worried about near-term inflation prospects. But medium-term measures of inflation expectations have barely budged. In other words, ordinary Americans agree that we are seeing a transitory rise in inflation. Those survey results reflect the fact that inflation has remained low and relatively steady for several decades and that the public believes the Fed is committed to keeping inflation under control. As long as household, business, and investor inflation expectations remain stable, then it’s unlikely that an inflationary dynamic will become established or that underlying inflation will jump sharply. Read the full speech here .
  • Interactive Map: Tough Oil

    The era of Tough Oil is here, according to our friends over at Marketplace . To mark the 1 year anniversary of the BP oil spill, they put together a terrific interactive map that tells the story of global oil production over the last half century. We have a snapshot of it below, but you must click here to see the map in full size and full effect.
  • Economist: 'Oil and the Arab Uprisings'

    Yesterday White House Chief of Staff William Daley said the Obama administration is considering tapping into the strategic oil reserves , signaling that the White House is concerned that the unrest in Libya might set off a case of supply shock. Libya is the 13th largest oil exporter, according to The Economist . As of now, the top oil exporter, Saudi Arabia, is increasing its output to make up for Libya's. But if that stops, and/or we see a cut in the supply from other countries in the region, like Algeria, we would be in for a big jump in oil prices. The Economist offers up this narrated slide show to explain the potential impact of an extended shutdown of Libyan oil exports on oil prices:
  • The Economist's Breakfast Index Shows Steep Rise in Prices

    When you sat down to eat breakfast this morning, did you think about how much more expensive it was than months past? Maybe you didn't. And maybe it wasn't much more expensive. But globally, breakfast commodity prices wheat, orange juice, and coffee, have all risen substantially. So now The Economist gives us The Breakfast Index, which shows the dramatic rise (25% in "rich nations") of the cost of your breakfast: Read more about the breakfast index here . (H/t Chart Port).