Turn in Thursday for News

Thursday will bring two big releases of national economic data with significant implications for the Wichita economy.

9:00 A.M. Central Daylight Savings Time: The Bureau of Economic Analysis (of the Commerce Department) will issue data for May manufacturing orders, shipments, backlogs, etc. While total new orders are an important cyclical indicator, we in Wichita will be particularly interested in the new and unfilled orders for the aerospace industry. This will not include the impact of Quantas' recent cancellation of orders for 15 Dreamliners.

7:30 A.M. Central Daylight Savings Time: The June employment report. Normally this would be issued Friday, but the Bureau of Labor Statistics is moving it up a day for the Independence Day holiday. The consensus of forecasts is that it will show a loss of 350,000 jobs on nonfarm payrolls and the unemployment rate up to 9.6 percent.

What to look for: A better showing on job losses would support our thesis that the economy has bottomed out. Even without a significant surprise from the payroll data, the report may better expectations on the unemployment rate which is based on the notoriously noisy household survey. The household survey also gives an alternative measure of employment. Analysts tend to ignore this measure for techical reasons, however I have found a careful analysis of these data gives better signals at turning points. By this metric the decline in employment has moderated even more than manefested on the establishment survey. Look for further confirmation of bottoming out. The non aerospace component of Wichita's economy needs to see a pickup in activity in the national economy.

The Bank of China Has Elevated Zhou Xiaochuan's Call for International Monetary Reform

Mr. Zhou Xiaochuan, is the People's Bank of China's Governor and Chairman of the Monetary Policy Committee. He published a paper on March 23, 2009 calling for increased use of the SDR as a reserve currency. Read Governor Zhou Xiaochuan's call to "Reform the International Monetary System" on the Bank's web site.

Robert Flint in the Wall Street Journal tells us, "In its 2009 financial-stability report on Friday, the People's Bank of China elevated the status of earlier suggestions for a new international currency. The ideas put forward in March in an essay by central bank governor Zhou Xiaochuan have now become part of the official view.

"The report is essentially a reiteration of the call in Mr. Zhou's essay for expanded use of Special Drawing Rights, a basket of currencies used by the International Monetary Fund. There is nothing in the stability report that hasn't been stated before.

"The central bank took a big step when it published Mr. Zhou's essay in English on its Web site in March. But to make his views a central-bank-backed position puts more authority behind the call for a new reserve currency.

"The central bank is an arm of the Chinese government and ultimately answers to the State Council, the country's highest governing body."

China to Be Long On Gold & Real Estate and Short on the Dollar

Zhou Xin and Alan Wheatley report in the Guardian, "Li Lianzhong, who heads the economic department of the Party's policy research office, said China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resource assets.

"Speaking at a foreign exchange and gold forum, Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.

"'Should we buy gold or U.S. Treasuries?' Li asked. 'The U.S. is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the dollar will fall. So gold should be a better choice.'"

China has 1,054 metric tonnes which, with gold selling at $941/oz, is worth $35 billion compared to America's 8,133.5 metric tonnes worth $270 billion.

Dow Jones reported that gold was up during the day's trading: "The initial rise occurred on a day when the U.S. dollar weakened partly in response to comments from the People's Bank of China saying it will push for reform of the international currency system to make it more diversified and reduce over-reliance on the current reserve currencies, primarily the dollar. This particularly caught the eye of gold traders a day after a senior economic researcher in the Communist Party expressed concern about the dollar and said gold could be a better alternative.

"'The People's Bank of China's call for a new global reserve currency or super-sovereign currency will likely lead to further pressure on the dollar and gold buying,' said Mark O'Byrne, director of bullion dealer GoldCore. "


The BRIC countries have called for the creation of a new reserve currency or at least a reduced dependence on the dollar.

According to Zhou Xin and Alan Wheatley, "China disclosed on April 24 that it had increased its holdings of gold to 1,054 tonnes from 600 tonnes since 2003.

"However, China's foreign exchange reserves have grown so fast over the same period that gold's share of the stockpile, the largest in the world, has shrunk.

"Li cited the high share of gold in the foreign exchange reserves of the United States, Italy, Germany and France, to argue that China's gold holdings, which account for about 1.6 percent of its reserves, are too small.

REFORMING THE SDR

"China does not disclose the composition of its currency reserves, but bankers assume around 70 percent of it is held in dollar assets.

"China is the largest single holder of U.S. Treasuries, with $763.5 billion at the end of April, according to U.S. Treasury data. [ID:nTRU000389].

"Analysts say this data set understates the true number as it does not capture paper bought through dealers in London or elsewhere.

"Li said a second reason for buying more gold would be in anticipation of the yuan one day becoming a reserve currency.

"The yuan is not convertible on the capital account, meaning it cannot be freely traded for other currencies for financial transactions that are not related to trade.

"This rules out the yuan's use as an international reserve currency, for central banks would not be able to convert it quickly if necessary.

"But, in a very preliminary step towards that goal, China is paving the way for greater use of the yuan beyond its borders.

"
The People's Bank of China has arranged currency swap deals with six countries since December totaling 650 billion yuan ($95 billion) so that trade and investment with China can be conducted in yuan, not dollars.

"And China will soon allow selected firms in the southern province of Guangdong that trade with Hong Kong to settle their transactions in yuan, or renminbi.

"'If the yuan should go international or become a reserve currency, China needs more gold to back that,' Li said.

"When the yuan does become an international currency, which Li acknowledged was a long way off, he said the composition of the SDR should be reformed to include the Chinese currency.

Ideally, in the long term, the SDR would be made up of the dollar, euro, sterling and yen and yuan, each with a weighting of 20 percent, Li said.

"The SDR is currently made up of the dollar (with a weighting of 44 percent), the euro (34 percent), the yen (11 percent) and sterling (11 percent)

"The four currencies in the SDR, which must be convertible, are those issued by Fund members with the largest share of global trade. The weights assigned by the IMF are based on the value of exports and the amount of reserves denominated in those currencies.

"The composition of the basket is reviewed every five years. the next review is due in 2010."

Is Immunizing the U.S. Economy Against the Dutch Disease So Bad?

I have written that "Plain Vanilla Banks Must Wax and Wall Street Must Wane." The Wall Street Journal's David Weidner seems to think that is a bad idea, especially to the extent it is a policy goal of the Obama administration. In today's "The Perils of a Smaller Wall Street: Reforms Seek Smaller Pockets of Risk, but Globally, Big Firms Still Dominate," he notes there are now only two U.S. banks in the world's top ten (JPMorgan and Citi) and they are near the bottom.

How bad is it that we are no longer the Masters of the Universe? It is not that long ago that Japan had eight of the ten spots on that list. The result? The next ten years were a lost decade for the Japanese economy. Is this just another example of post hoc, ergo propter hoc (the logical fallacy of "after this, therefore because of this)? Japan had a bubble because of a huge overexpansion in credit, foreign financed after financial deregulation. Inflated capital led to overexpansion of banks and a monster bubble. Bubbles burst. Bubbles distort incentives and misallocate resources. Like inflation, bubbles are bad and are caused by bad policy.

The United States has suffered from a virulent form of the Dutch disease these last twenty years. As Wall Street has sucked in capital from all over the world, manufacturing has been hollowed out. As value added in the financial sector grew, our competitiveness waned.

The White House White Paper is largely ratifying reality. (See below and today's Eagle: "New financial rules explained.") The more prudent banks (JPMorgan, Intrust) will prosper. The others have been shrunk in true capitalist fashion. If the financial sector shrinks, so be it.

China's First "Domestically" Assembled A320 Rolls Off the Assemply Line

Airbus has set up an assembly line in China and the Wall Street Journal reports the first dragon plane came off it.

On FT/com: Good CFO

Numbers guys you can count on

By Luke Johnson

I have hired quite a few finance directors over the years. Some were outstanding; others did not work out so well. Inevitably, I have acquired some views about what makes a great numbers guy.

I prefer working with someone fundamentally conservative. Bullish chief finance officers are dangerous. The leader of a business needs to be an optimist, and sales-oriented. But every business needs at least one person at the top alongside them to worry about the downside. I insist that the senior finance person is a qualified accountant. Whether they are a certified public accountant or a chartered accountant, they will have been taught how vital prudence is when preparing accounts, budgets and so forth. I am always astonished at how huge US corporations, like Enron and leading investment banks, can hire go-go MBAs as their CFOs. No wonder they got into trouble.

The CFO must be able to assemble and analyse financial statements themselves: I do not want a quick-talking professional who has risen so far that they do not understand the business’s accounting systems. But they must also be able to see the whole picture and not get so immersed in detail that they overlook major issues – a surprisingly common failing.

The CFO must also be able to explain treatments, policies and consequences so that every executive can understand them. The best accountants do not hide behind jargon or technical mumbo-jumbo. Great accountants are so familiar with the company’s books that they can swiftly identify each entry, liabilities and assets, every item of income and expense, flows of cash, margins and all the rest, where material.

Some CFOs get bored with things like management accounts, and really want to be corporate financiers. They would rather be doing deals, having power lunches and indulging in the whole merry-go-round, rather than crunching the numbers. Those tasks have their place, but they are not the first order of business. Principally, the CFO must be in absolute command of the figures and financial basics, such as tax, debt and key ratios. Only once they have total mastery of vital administration should they be thinking about the sexy stuff like M&As.

As well as highly numerate, a modern CFO must be something of an IT expert. There are still a surprising number of finance professionals who struggle to use even unsophisticated accounting software. It must be a devastating disadvantage for anyone performing a high level finance job in the 21st century. Similarly, a rounded CFO will have a thorough knowledge of property – leases, financing and the rest – and insurance, as well as a good grounding in corporate law and company secretarial affairs.

The best CFOs have a close, mutually respectful, but not subservient relationship with the chief executive. Those who never disagree and do not stand up to their boss on key matters are not worth having. Ultimately, shareholders and the board place huge faith in the CFO. Whoever fills the post must be independently minded and a strong enough character to deliver the truth to the owners and non-executives – no matter how unpalatable. While every CFO should be a partner to the CEO, they should always believe they report to the board and owners of a corporation.

As with every senior role, an ability to manage people and a sense of humour are critical. But with a CFO, absolute integrity and a capacity for hard work are even more important. During difficult times the role cannot be executed in 40 hours a week and a holiday entitlement of six weeks. Periods of crisis call for all hands to the pump. CFOs are the ones who are managing costs, coping with foreign exchange risks, dealing with pressing bankers and covenants, collecting overdue money and ensuring the auditors do not qualify the accounts. A proper company cannot function without a decent finance director at the helm, supervising, informing and warning.

They may not win all the applause as corporate heroes, but without their contribution even the sexiest business would soon be in trouble.

Copyright The Financial Times Limited 2009

Can the Fed Go Belly Up?

During the bubble years, we worried that investment banks got overlevered running up leverage ratios (ratios of assets to equity) of thirty and forty times. We all know what happened then.

The Federal Reserve Bank of New York's Consolidated Balance Sheet shows its leverage ratio was 37.5 times at year end 2007. Its President in 2008 was a Timothy Geitner (now Secretary of the Treasury.) At the end of 2008, the Fed of New York achieved a leverage ratio of 112.5 times.

Maybe their old boss can bail them out if they go bust now that some banks are buying back TARP stock.

The White Paper Outlining Regulatory Reform

Yesterday in a series of public interviews and announcements, the administration in Washington put forth its proposed reform of U.S. financial regulation. The proposal itself is embodied in an 89 page White Paper, "Financial Regulatory Reform: A New Foundation." It is a combination of the "art of the possible," America's penchant for committees, and ratification of the de facto reality.

Otto von Bismark declared, "Politics is the art of the possible." President Obama is realistic about what he can get through Congress and what he can not. Simplifying and consolidating the patchwork quilt of prudential and financial services regulation would provoke a huge turf war that would stall this legislation and much of the rest of his agenda.

The Fed is a big winner. It gains authority to regulate any firm which is a systemic threat to the financial system. A GE Capital or an American Express could come under its prudential regulation if it is big enough and/or interrelated enough to be a source of systemic risk. The New Deal left investment banks largely outside the circle of prudential regulation. The financial crisis drove the main investment banks either out of business or into bank holding companies as permitted under Gramm-Leach-Bliley. Thus the remaining major investment banks are already under the Fed's regulation. Other large or potentially system threatening firms could be designated "Tier 1 Financial Holding Companies" (Tier 1 FHCs) even though they do not hold subsidiaries that issue deposits. Importantly the Fed will regulated these Tier 1 FHCs on a consolidated basis. Bear in mind that the Fed is the only agency that has the firepower to deal with systemically threatening businesses.

Although the Fed will be the prudential regulator for Tier 1 FHCs, it is not clear who will put up the capital for non banks that need to be resolved in a liquidation. It appears the Treasury is to resolve these situations, but will it require a prior Congressional appropriation such as TARP did?

It looks like Tier 1 FHCs will be required to hold to more stringent capital requirements. It is not clear whether that is more stringent that non Tier 1 FHCs or more stringent than pre-crisis requirements.

The Treasury will chair a Financial Services Oversight Council. The Office of Thrift Supervision disappears, but there will be a new Consumer Financial Protection Agency.

Securitization and such derivatives as Credit Default Swaps were at the heart of the financial crisis. Firms issuing securitized obligations will have to have some "skin" in the game much like European income bonds or the Federal Home Loan programs. Excellent idea!

The proposal calls for more comprehensive regulation of derivatives. I will need to dig into the details before I can determine how much beef there is in the rhetorical receipe. The Fed gains authority over "systemically important payment, clearing, and settlements systems."

The split in authority between the SEC and the CFTC continues, but the Financial Services Oversight Council can adjudicate disputes. Will it intervene when neither does its job? Remember Enron?

Some thoughts:

Bigger capital requirements on the big boys is effectively a tax on their ROE. It is not necessarily a bad thing that Wall Street shrinks and the small fry gain, but Wall Street has its lobbying clout to be delt with.

The proposal seems to call for a pullback from Basel II and greater capital requirements for risky assets. At the same time it calls for "a simple, non-risk based capital measure to limit the amount of leverage built up in the international financial system." This sounds like squareing the circle to me.

There is a call for less procyclical capital requirements. Spain is the star in this credit crisis. By adopting capital requirements that go up in a boom and are smoothed in a bust, Spain's banks (much like Brazil's) come out of the crisis is relatively good shape. Spain was not saved from a housing bubble, however. It would be impolite to point out that the Fed, the White Paper's big regulatory winner, caused the bubble in the first place.

There are considerable words about firm value accounting and transparancy. The White Paper requires that accounting be looked into again. I seem to remember that mark to market accounting was at the heart of the Enron debacle. Enron and WorldCom led to financial institutions' being subject to greater market to market accounting. Those commissioned to look into these issues will find the conflict between fair market accounting and banks' function of intermediation illiquid loans a difficult nut to crack.

There Is Some Cross Price Elasticity Between Coal and Natural Gas

Rebecca Smith and Ben Casselman report in the Wall Street Journal that falling natural gas prices are gaining it market share in the electricity market at coal's expense. There appears to be a non zero cross price elasticity between coal and natural gas in this market. No doubt there is more in the longer run than the shorter run.