Goldman is Bearish on Europe

Pot notices the deep dark color of the kettle.

Buy `Crash Protection' Puts on European Stocks, Goldman Says
By Alexis Xydias

June 30 (Bloomberg) -- Investors should buy ``crash protection'' against a plunge this year in European stocks because losses are likely and insurance costs are low, according to Goldman Sachs Group Inc.

The world's most-profitable securities firm recommended Dow Jones Euro Stoxx 50 Index puts that expire in December and have a strike price of 3,000, or 11 percent less than the measure's closing level today.

`High inflation/low growth is an increasing downside tail risk,'' London-based derivatives analysts at Goldman, which had the second-ranked equity derivatives research team in Institutional Investor magazine's 2007 survey, wrote in a report dated June 26. ``If that risk crystallizes, we think it means material rather than modest downside.''

The Euro Stoxx 50 plunged 24 percent to 3,354.20 in 2008 and closed at the lowest since November 2005 last week. The December 3,000 puts on the index fell 6.7 percent to 83.50 euros today. They cost as much as 189.30 euros in March.

European-style puts convey the right to sell a security for a certain amount, the strike price, on a given date. Some investors buy or sell options to guard against changes in the prices of securities they already own. Others use the contracts to bet price swings, or volatility, will increase or decrease.

To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net.

BIS: Dr. Greenspan, in the Ballroom, with a Printing Press

BIS points finger at easy credit
Monday, 30 June 2008 11:46
RTÉ Ireland

The world's top central banking body has said the world economy could be in for an unexpectedly severe downturn. The Bank for International Settlements blamed lax credit for fuelling the current financial crisis.

The bank, known as the central bankers' central bank, suggested that interest rates should tend towards vigilance even in good times in order to discourage excessive borrowing.

While it was difficult to predict the severity of a downturn, it appeared that a 'deeper and more protracted global downturn than the consensus view seems to expect' was on the way, the BIS said.

It dampened hopes that booming emerging markets would offset the slowdown, saying that many of these markets were significantly dependent on external demand, notably from the world's largest economy the US.

The BIS argued that the sub-prime mortgage market - loans given to borrowers with poor credit ratings - was not a root cause of the turmoil on financial markets, but only a trigger.

The bank said years of cheap borrowing had led to an extraordinary accumulation of debt. It pointed out that in the US, the ratio of household savings to disposable income was about 7.5% in 1992. The ratio fell sharply in the early 2000s. By 2005, it had plunged to almost zero.

Larry Summer's Design for an Economic Maginot Line

Larry Summers is an old general among the Keynesian-statist crowd. His playbook is right out of command and control economies, fighting a new type of war with the old tactics and weapons.

Don't get us wrong, we believe that something must be done and we have laid out broad plans months ago. But what Larry is proposing is a repugnant continuation of the same old game, which is the same prescription the Fed has been following since 1987.

What we can do in this dangerous moment
By Lawrence Summers
Financial Times
June 29 2008 18:10

It is quite possible that we are now at the most dangerous moment since the American financial crisis began last August. Staggering increases in the prices of oil and other commodities have brought American consumer confidence to new lows and raised serious concerns about inflation, thereby limiting the capacity of monetary policy to respond to a financial sector which – judging by equity values – is at its weakest point since the crisis began. With housing values still falling and growing evidence that problems are spreading to the construction and consumer credit sectors, there is a possibility that a faltering economy damages the financial system, which weakens the economy further.

After a period of intense activity at the beginning of the year with the passage of fiscal stimulus legislation, strong action by the Federal Reserve to cut rates and provide liquidity and the introduction of anti-foreclosure legislation, policy has again fallen behind the curve. The only important policy actions of the past several months have been those forced on the Fed by the Bear Stearns crisis. It would be a mistake to overstate the extent to which policy can forestall the gathering storm. But the prospects for a more favourable outcome would be enhanced if four actions were taken promptly.

First, the much debated housing bill should be passed immediately by Congress and signed into law. It provides some support for mortgage debt reduction and strengthens the government’s hand in its troubled relationship with the government-sponsored enterprises – Fannie Mae and Freddie Mac. While it is an imperfect vehicle – too limited in the scope it provides for debt reduction, insufficiently aggressive in strengthening GSE regulation and failing to increase the leverage of homeowners in their negotiations with creditors through bankruptcy reform – it would contribute to the repair of the nation’s housing finance system. Failure to pass even this minimal measure would undermine confidence.

Second, Congress should move promptly to pass further fiscal measures to respond to our economic difficulties. The economy would be in a far worse state if fiscal stimulus had not come on line two months ago. The forecasting community is having increasing doubts about the fourth quarter of this year and beginning of the next as the impact of the current round of stimulus fades. With long-term unemployment at recession levels, there is a clear case for extending the duration of unemployment insurance benefits. There is now also a case for carefully designed support for infrastructure investment, as financial strains have distorted the municipal credit markets to the point where even the highest-quality municipal borrowers are, despite their tax advantage, paying more than the federal government to borrow. There are legitimate questions about how rapidly the impact of infrastructure spending will be felt. But with construction employment in free fall, there will be a need for stimulus tied to the needs of less educated male workers for quite some time. Fiscal stimulus measures must be coupled to budget process reform that provides reassurance that, once the crisis passes, the fiscal policy discipline of the 1990s will be re-established.

Third, policymakers need to make a clear commitment to addressing the non-monetary factors causing inflation concerns. Though this could change rapidly and vigilance is necessary, it does not now appear that there are embedded expectations of a continuing wage price spiral. Rather, the primary source of inflation concern is increases in the price of oil, food and other commodities. Even if structural measures to address these issues do not have an immediate impact on commodity prices, they may serve to address medium-term inflation expectations. Appropriate steps include reform of misguided ethanol subsidies that distort grain markets to minimal environmental benefit, allowing farm land now being conserved to be planted; measures to promote the use of natural gas; and reform of Strategic Petroleum Reserve Policy to encourage swaps at times when the market is indicating short supply. Major importance should be attached to encouraging the reduction or elimination of energy subsidies in the developing world.

Fourth, it needs to be recognised that in the months ahead there is the real possibility that significant financial institutions will encounter not just liquidity but solvency problems as the economy deteriorates and further writedowns prove necessary. Markets are anticipating further cuts in financial institution dividends; regulators should encourage this to happen sooner rather than later and more broadly to reduce stigma. They should also recognise that no one can afford to be too picky about the timing or source of capital infusions and rapidly complete the review of regulations that limit the ability of private equity capital to come into the banking system. Most important, regulators should do what is necessary, including possibly seeking new legislative authority, to assure that in the event of an institution becoming insolvent they can manage the resolution in a way that protects the system while also protecting taxpayers. It was fortunate that a natural merger partner was available when Bear Stearns failed – we may not be so lucky next time.

Unfortunately we are in an economic environment where we have more to fear than fear itself. But this is no excuse for fatalism. The policy choices made in the next few months will matter to the lives of millions of Americans, to America’s economic strength and to the global economy.

The writer is Charles W. Eliot university professor at Harvard University and a managing director of D.E. Shaw & Co

An Interview with Peter Schiff from Barron's

Peter Schiff is an interesting character, with an interesting perspective which he is quite articulate in expressing despite significant bias on numerous financial interviews. We disagree with him on a number of points, in particular with the 'cure' to our economic ills. We enjoy reading various perspectives as long as they are based on facts and stated intelligently. Peter Schiff does this quite well and we hope you enjoy this interview with Barron's.


Gloom and Doom? Nah; Just for the U.S.
By Lawrence C. Strauss
Barron's

The U.S. wouldn't be afloat without help.

Peter D. Schiff is an extreme bear when it comes to investing in the U.S., and he's made a name for himself selling his point of view with considerable zeal, often on television but also in print. Schiff, 43, has contributed articles to Newsweek International and other publications, and he is the author of the recently published Crash Proof: How to Profit from the Coming Economic Collapse. Our own Alan Abelson cited his musings in a recent column.

However, comparing Schiff's performance with a benchmark is impossible because he does not run a fund; instead, he recommends stocks for clients' brokerage accounts. Schiff, who holds a degree in finance and accounting from the University of California at Berkeley, is president and chief global strategist of Euro Pacific Capital, a brokerage he founded in the mid-1990s that emphasizes international stocks, preferably with dividends.

Not everybody is a fan. Schiff has been criticized for aggressively courting publicity to tout his doomsday message relating to U.S. equities and the domestic economy. But he has been right on several key calls, notably the weakening greenback and his emphasis on international stocks, and he has helped his clients make money. Barron's caught up with him recently.

Barron's: When did you turn bearish on the U.S.?

Schiff: A long time ago I worked as a retail broker at Shearson Lehman Brothers and I was selling tech stocks, and I was generally bullish. I had difficulties with some of the problems in our economy, but I was recommending U.S. stocks. I left Lehman in 1991. In the mid-1990s, when I was working for a small broker-dealer in California and then for my own firm, I started getting concerned about the dollar. So I began getting some clients invested in some foreign stocks -- just to get out of the dollar a bit. The dollar had a big drop, and then it started to rally in the late-1990s, in conjunction with the tech bubble. It was all part of foreigners' efforts to try to participate in the Nasdaq's bubble.

What kinds of stocks did you like in those days?

Traditional value stocks with dividend yields. I also liked commodities, so I was buying international oil stocks back when oil was under $20 a barrel. The stocks I recommended weren't doing very well in '98 or '99, especially after the Asian crisis, but they started doing better around 2000. I turned really, really bearish on the U.S. when I saw what the Federal Reserve was doing to prevent a recession in the early part of this decade, notably pumping a lot of liquidity into the system.

You continue to be very bearish on the U.S. But haven't there been other times when there was lots of negative sentiment toward the U.S., only to see another era of prosperity emerge? Such as the late 1980s, when there was concern that Japan would take over the U.S. economy. Look at how that turned out.

Yes, but we haven't been through anything like what we are going through now. The United States has really been living in a fool's paradise, or a phony economy, probably for more than 20 years. But our economy has been growing and getting bigger and bigger. We have been able to convince the world to lend us money and to provide us with goods that we don't produce and that we can't afford to pay for with exports. And it has gotten to the point now where the problem is so big, especially since the real-estate bubble. We've now borrowed so much money from abroad. Our trade deficits are now very big, and our industrial base and our infrastructure have been allowed to decay for so long, that we are now at a point that we can only survive as an economy thanks to the charity of the rest of the world. They have provided us with all the goods that we can no longer produce because we lack the industrial capacity. And they have to lend us the money because we don't have any savings anymore.

What's your take on oil prices?

As oil prices are going up in the U.S., they are not rising nearly as fast in other countries because their currencies are strengthening. Ultimately, when currencies like the renminbi that are pegged to the dollar are allowed to float, I see the Chinese currency rising five-fold against the dollar. That would make oil a lot cheaper in China relative to what it would cost in the U.S.

Speaking of China, how do you see things developing there and its impact on the U.S. economy?

The whole science of economics, as I see it, is how do you satisfy unlimited demand with limited resources? China has more than one billion people. It is not as if Americans are unique in wanting things. It's not as if the Chinese don't want dishwashers. The reason they don't have those possessions is because they don't have the purchasing power. But they do have that power; it's just that their government is taking it away from them and giving it to us. But it is Americans who can't afford these goods, because we can't produce them. So if the renminbi is allowed to rise, then Chinese factory workers will be able to afford the products they are producing instead of shipping them over here. That's going to be a major, major boon for their economy.

So it sounds as if the U.S. will be relegated to second- or third-tier status.

The U.S. is in trouble. We are a post-industrial society, which is the same as a pre-industrial society; our manufacturing base has disintegrated. It's not nonexistent; we still make some things and we are still competitive in some areas. But on the whole, as a nation we are not competitive. We are mainly a nation of a service sector and consumers, and that's going to have to change. Nor do we have the savings that we need to fund the transition.

What could go wrong with your scenario?

Somehow, the U.S. could buy itself some additional time. We could convince the world -- Europe and Asia -- that they need us, and that while propping up the U.S. economy is going to hurt them with more inflation, letting the U.S. collapse is going to be even worse. Of course, none of that is true. The truth, in my view, is that the cost of propping us up far exceeds the cost of letting the U.S. economy collapse. But I think we are already in a pretty severe recession.

But isn't there an argument that once we clean up this housing mess -- along with the credit bubble, whenever that occurs -- the U.S. will be a lot closer to a bottom, where the outlook begins to improve?

I don't think that's true. The resolution to the housing problem is going to mean housing prices are going to be a lot lower than they are now, and most Americans are not going to have any home equity. It's going to mean that trillions of dollars will have been lost by the lenders. When the home equity is gone, Americans are broke, as they don't have any savings. All they had was their home equity. They were counting on their home equity, without which they will be unable to pay off their credit cards.

But don't U.S. companies that do business abroad benefit from all of the trends you have outlined?

Yes, they are going to benefit to the extent that they can generate higher sales abroad. But ultimately the shareholders are not necessarily benefiting just because a multinational company earns more dollars. If the dollars have less purchasing power, they are not necessarily better off. The way I see it, we are just putting our goods on sale to sell more of those goods. But if you want to look at U.S. corporate earnings in terms of euros, barrels of oil or gold bullion, these companies are not necessarily seeing a real increase in earnings.

Plenty of investors and financial advisers have decreased their allocations to U.S. stocks in recent years. Why not do that instead of completely writing off the world's largest economy?

Individuals can make their own decisions. I don't see a way for the U.S. economy to avoid a major retrenchment. There's no way that U.S. assets are not going to be marked down relative to foreign assets. Therefore, I would rather invest in the rest of the world. There are plenty of people who for the whole decade of the 1990s were investing everywhere but Japan, which is the second biggest economy in the world. Why were they excluding Japan? It was obvious that it was in decline. I'm saying the same thing about the United States. I don't care if it is the biggest economy in the world; it is in decline. There are going to be a lot of losses in the United States, so why don't I avoid it? Worst-case scenario: I miss out on the U.S. market. But what are the odds that it is going to outperform all the other major markets that I am investing in? And I can't see how the dollar is going to be moving up over time.

Why keep your business open here? Why not set up shop in Asia?

Right now my business is helping Americans to preserve their wealth from a collapse of the U.S. dollar. If I were to go to a different country, obviously I would have to come up with a different business. I don't think people in China need to protect their wealth; they are going to do great. My business works better here. I could try to run the business from overseas, say the Cayman Islands or Australia, but I have friends and family here. I'm optimistic.

I've supported political candidates in the U.S., including Ron Paul, who ran for the Republican presidential nomination this year. I'm not writing America off. But I'm trying to educate people so that they understand that when this economy does collapse, it is not because of capitalism but that it's because of too much government.

What kinds of stocks do you look for?

The dividend is the most overlooked and important component of equity investing. Capital appreciation is great, but that's the icing; the cake is the dividend yield. I look for good dividend yields, but I want to get them in currencies that are gaining in value so that my clients can maintain their purchasing power here. These companies are playing into the growing purchasing power of the rest of the world -- not the shrinking purchasing power of the United States. The rest of the world has been selling us goods and hoarding our Treasuries and mortgage-backed securities. They are not going to be doing that anymore. They are going to spend their earnings on themselves.

How about a few stocks that you like?

One of the mining stocks that I have been buying, although it has pulled back a lot, is Oxiana [ticker: OXR.Australia]. Oxiana and Ziniflex, another Australian mining company, just merged. Another holding is an infrastructure play called Road King Infrastructure [1098.Hong Kong], which is listed in Hong Kong. It's also pulled back quite a bit. I also like Singapore Petroleum [SPC.Singapore]. Those are three names I've have been buying recently. One is a play on the growing infrastructure in China, while the other two are ways to invest in resources. A lot of people look at me and say, "Peter you are gloom and doom." I'm not gloom and doom.

Well, you are pretty gloomy on investing in the U.S.

I'm very negative on the U.S. economy. But I'm very optimistic on a lot of other economies. A lot of people tell me, 'Peter, this doesn't make any sense. How can you be so dire and gloomy on the U.S. and yet so positive on the rest of the world?' That shows you I'm not just gloom and doom. I recognize that contrary to popular opinion, the U.S. economy has been a drag on the global economy, and that when the rest of the world stops subsidizing us, growth abroad will actually improve as a result.

Surely you see some light at the end of the tunnel for the U.S.?

It is a long tunnel and the light is far away. But, yes, in the end I'm still optimistic that we can one day dig ourselves out of this hole. Look at the Germans and Japanese. They lost World War II, but here they are. We didn't lose a war, but in many respects we did in that our factories have been destroyed even though they weren't bombed.

What's a reasonable plan for the U.S. to right the economic ship?

We are going to have to replenish our savings. We are going to have to rebuild our industry. We are going to have to repair our infrastructure. All of that is possible, though it's not easy. It's going to be very difficult given the current level of government we have, along with the types of taxation and regulations we have. To really rebuild the economy, we are going to need cooperation from government and the government is going to have to get out of the way and make itself a much smaller burden on society, which means major reductions in government spending, taxes and regulations.

Thanks, Peter.