bizzXceleration: Performance, Value and Profit

Big Picture

BIS: Economy Nears 'Tipping Point' (WSJ) The global economy may be close to a "tipping point" that could see it enter a slowdown so severe that it transforms the current period of rising inflation into a period of falling prices, the Bank for International Settlements said. In its annual report, the central bank for central banks said the impact of rising food and energy prices on consumers' incomes, combined with heavy household debts and a pullback in bank lending, may lead to a slowdown in global growth that "could prove to be much greater and longer-lasting than would be required to keep inflation under control." "Over time, this could potentially even lead to deflation," it said. For central bankers from around the world gathered in Basel for the BIS annual meeting Sunday and Monday, the report made for chastening reading. Not only does it highlight the difficulty of the dilemma facing central banks confronted with slowing growth at a time when inflationary pressures are rising, it also lays much of the blame for their predicament at the feet of the central banks themselves. The BIS said that in the early part of this decade, central banks had failed to set interest rates high enough to restrain an unsustainable credit boom. It added that if a repeat of the current financial crisis is to be avoided in the future, central banks must be prepared to keep interest rates high even when there are no obvious signs that inflation rates are about to pick up. It also suggested that regulators make banks set aside more capital during boom times -- an approach that could curb their risk-taking and lessen their need to pull back on lending during busts.

Weak economic reports hurt yen and euro against dollar (WSJ) The dollar rose against the yen and euro Monday after disappointing economic reports in the euro zone and Japan transferred investor concerns to economies outside the U.S. The euro tumbled against other major currencies after the widely watched Ifo survey showed that business sentiment had fallen to 101.3 in June from 103.5 in May, well below forecasts. A weak euro-zone Manufacturing Purchasing Managers Index extended the euro's decline. It showed activity in the euro-zone economy fell to its weakest level in five years during June. In a Japanese survey, large companies were more pessimistic about business conditions in the April-June quarter than they were during the previous quarter.

Watch Out for Sovereign Debt Risk Optimists say that emerging-market defaults are a thing of the past. Emerging markets today, the argument goes, are relying more on domestically issued local currency debt, both inflation-indexed and non-indexed. This means their debts are far more stable and reliable than in the recent past, when a much larger share of government debt was issued externally and denominated in hard currency. This argument is wrong. In the past, the combination of high levels of domestic debt and inflation surges has often proven deadly for both foreign and domestic investors. Just look at Argentina today, a country not nearly as prosperous as its abundant natural resources would warrant. If external debt holders think that abuse of domestic debt holders is no cause for alarm, they should think again. Governments do not usually cheat holders of only one type of debt. In April, we published a National Bureau of Economic Research paper based on centuries of debt data from many countries. We found that most countries default on external debt only a bit less freely than on domestic debt. That is, contrary to popular belief, domestic debt holders are not necessarily a cushion for "senior claimants" holding externally issued debt. Emerging markets could be in much greater trouble than the optimistic consensus suggests. If today's tepid growth in the U.S., Japan and Europe begins to take hold in emerging markets, Argentina's miserable indexed bond holders may soon have company.

How to see world economy through two crises [Chart] Two storms are buffeting the world economy: an inflationary commodity-price storm and a deflationary financial one. Last week I argued that exchange-rate regimes were a link between these distinct events. This week, let us look at how to sail on these storm-tossed seas. The place to start is with the world economy as a unit. The more globalised economies become, the more appropriate it is to think of the world economy in this way. So what have we learnt about the world economy as a whole? The answer is that it is running into limits on resources, at least in the short term. Our civilisation is based on fossil fuel. But since the end of 2001, the real price of oil has risen some six-fold. Today, the real price is higher than since the beginning of the previous century. Against this difficult background, what are the right responses and how should they be distributed, across the globe? These need to be divided into the short term and the longer term. In the short term, the biggest monetary policy requirement is a tightening in emerging economies, many of which now have strongly negative real interest rates. A precondition for such a tightening is a relaxation of exchange rate targeting. Monetary tightening is less obviously necessary in high-income countries, though the US Federal Reserve may have cut too far. As important is letting the jumps in energy prices pass through, so forcing the needed adjustments in energy use. The beneficiaries of the subsidies offered by many emerging countries are overwhelmingly in upper-income groups. In the medium to long term, the biggest priority is to release energy constraints on growth. This means increased public and private investment in energy research, particularly in renewables. The challenge is huge, but must be met. The shocks are large. But the more significant one is the high price of energy. The financial crisis was an avoidable stupidity. Rising prices of energy are a bitter reality. The world must adjust to this unpleasant new threat. How imbalances led to credit crunch and inflation

Regions & Countries

Euro Zone Business Activity Falls Business activity in the euro zone contracted for the first time in five years, according to a closely watched business survey, as high oil prices, a strong currency and the threat of rising interest rates take their toll. Business activity in the euro zone contracted for the first time in five years, according to a closely watched business survey released Monday, as high oil prices, a strong currency and the threat of rising interest rates take their toll. The unexpectedly sharp drop in the euro zone's Purchasing Managers Index and a decline in Germany's Ifo Index of business confidence, also released Monday, suggest the global economic slowdown is now seriously affecting the 15-nation euro zone. That will complicate the European Central Bank's job of reining in inflation, economists say. A sharp fall in French business activity contributed particularly to the drop in the index. Even in Germany, Europe's largest economy, the survey suggested recent economic strength is fading. The euro zone's other main economies, Italy and Spain, are already experiencing pronounced economic downturns. The German Ifo Index fell by more than expected to 101.3 in June from 103.5 in May, hitting its lowest level since December 2005. German companies told Ifo, a Munich-based economics institute, they expect business conditions to deteriorate in the coming six months. Soaring oil prices are increasingly hurting the German economy, said Ifo President Hans-Werner Sinn. Germany's key manufacturing industries expect their export business to slow in coming months but not to collapse despite the high euro, he said. The euro-zone economy had until recently proved remarkably healthy in the face of slowing U.S. growth, financial-market turbulence, high energy prices and the euro's strength. That resilience appears to be fading.

• Contraction Possible in Germany (WSJ) German consumer sentiment worsened, a survey showed, while the government warned that the economy could stagnate or even contract this summer.
• U.K. Economic Growth Revised Down to 0.3% as Services Slump to 12-Year Low
• Europe Business, Consumer Sentiment Drops to 3-Year Low; Retail Sales Fall
• French First-Quarter GDP Growth Revised Down to 0.5% as Spending Stagnates

Harvard, Buffett Have Bad News for Asia Bulls: William Pesek There's much relief that Asia is holding its ground as the U.S. economy slows and credit-market woes humble Wall Street's biggest names. While asset markets are heading lower from Tokyo to Jakarta and Shanghai to Mumbai, healthy economic growth has confounded the pessimists -- so far. The knock-on effects are coming, just more stealthily than many expect. Asia is unlikely to get off easy even if the U.S. skirts a recession. The region hasn't decoupled from America as much as some would say. The worst-case scenario -- a prolonged U.S. decline -- could be devastating, particularly at a time when record oil and food prices are hurting Asian households. Billionaire investor Warren Buffett laid it out in a June 25 Bloomberg interview. He's unsure when the U.S. will recover. The idea that Asia will continue to display an impressive immunity to U.S. events ignores how dependent China is on the American economy. It also ignores how reliant Asia is on China's 10 percent growth. Slowing U.S. demand will chip away at that country's export-driven expansion exponentially.

China's Exports Threatened by Rising Costs These pressures are felt by enterprises across China. But none have been hit harder than the companies that feed the vast global appetite for inexpensive goods such as toys, household goods, shoes and clothes. Manufacturers of low-cost products have been a key engine of China's economic miracle, helping to turn the country into the world's No. 2 exporter after Germany. For years, these companies continued to grow by expanding their volumes and trimming margins to undercut the competition. As material and labor costs rise and China's currency strengthens, these manufacturers are among the least able to absorb the costs. The transformation is most apparent in the boomtowns that tied their fortunes to making one product cheaply, from Guangdong province in the south to Honghe's environs in the Yangtze River Delta. Many of these manufacturing centers have seen hundreds if not thousands of factories and workshops close in recent months, industry executives say. In Shengzhou, a city near Shanghai that claims to make one-third of the world's neckties, manufacturers are trying to hold a united front to boost prices. Dongguan, in Guangdong, is seeing makers of toys, shoes and brushes close shop. While painful, such difficulties could usher in a more mature phase of China's economic development. The country's sweater industry, like many others, is arguably overbuilt: Honghe is one of at least six Chinese cities claiming to produce more than 100 million sweaters annually. In such low-cost sectors, analysts predict a coming wave of consolidation that could boost efficiency. They say companies will also be forced to innovate so they can compete on factors other than price.Many Chinese economists and officials think the country has relied too much on cost-cutting and simple production models to boost exports.

India Steps Up Inflation Fight (WSJ) India's central bank raised its key rate a half point to 8.5% and increased banks' reserve ratio, in further moves to curb accelerating inflation. India's central bank raised its key short-term interest rate and the amount of cash banks must keep in reserve, employing both its chief inflation-fighting tools after price rises recently reached a 13-year high. The move was the latest in a months-long campaign by the Reserve Bank of India to curb the impact of rising food prices and the government's recent decision to remove some energy subsidies, which increased most fuel prices by about 10%.Wholesale price inflation, the chief benchmark of Indian prices, touched a 13-year high of 11.05% in the week ended June 7, more than double the central bank's comfort level of 5.5% for the year ending March 31, 2009. This time last year, annual inflation stood at 4.28%.

Dubai's $82 billion aerospace gamble Blessed with fewer oil and gas reserves than its neighbors, Dubai has long had to find other ways of making a living. For centuries not much more than a staging post and pearl-diving port along ancient Middle Eastern trading routes, it has most recently reinvented itself as a playground for the super rich, with a focus on extravagant Las Vegas-style real-estate projects such as the world's first seven-star hotel. A history of success at pulling off such grand schemes has emboldened Dubai of late. After diversifying its economy into real estate, tourism and financial services, it's recently turned its attention to the loftier aerospace sector. And why not? For a sheikdom at the crossroads of Europe and Asia, awash in cash and eager to have a say on the global stage, aerospace could be just the ticket, allowing it to parlay its ideal geographic location and rising international profile into an industry that will create jobs and support its economy in the long term. According to consultancy McKinsey, the Gulf economies need to create more than 4 million jobs over the next decade for its citizens. More than 350,000 new jobs could come from the aviation sector by 2015. While a chunk of the industry likes to portray Dubai as a somewhat clueless teenager indiscriminately spending daddy's money on vanity projects, it would be a mistake to dismiss the emirate's plans too hastily. "The level of ambition and the money and willingness to support it is staggering," said David Stewart, head of the European practice of consultancy AeroStrategy.

Issues: Food, Materials, Oil

Yes, We Will Have No Bananas  ONCE you become accustomed to gas at $4 a gallon, brace yourself for the next shocking retail threshold: bananas reaching $1 a pound. At that price, Americans may stop thinking of bananas as a cheap staple, and then a strategy that has served the big banana companies for more than a century — enabling them to turn an exotic, tropical fruit into an everyday favorite — will begin to unravel. The immediate reasons for the price increase are the rising cost of oil and reduced supply caused by floods in Ecuador, the world’s biggest banana exporter. But something larger is going on that will affect prices for years to come.That bananas have long been the cheapest fruit at the grocery store is astonishing. They’re grown thousands of miles away, they must be transported in cooled containers and even then they survive no more than two weeks after they’re cut off the tree. Apples, in contrast, are typically grown within a few hundred miles of the store and keep for months in a basket out in the garage. Yet apples traditionally have cost at least twice as much per pound as bananas. Americans eat as many bananas as apples and oranges combined, which is especially amazing when you consider that not so long ago, bananas were virtually unknown here. They became a staple only after the men who in the late 19th century founded the United Fruit Company (today’s Chiquita) figured out how to get bananas to American tables quickly — by clearing rainforest in Latin America, building railroads and communication networks and inventing refrigeration techniques to control ripening. The banana barons also marketed their product in ways that had never occurred to farmers or grocers before, by offering discount coupons, writing jingles and placing bananas in schoolbooks and on picture postcards. They even hired doctors to convince mothers that bananas were good for children. Once bananas had become widely popular, the companies kept costs low by exercising iron-fisted control over the Latin American countries where the fruit was grown.

Iron Deal to Lift China's Steel Costs (WSJ) Rio Tinto and BHP won an 85% increase in the benchmark price for iron ore after months of negotiating with China's top steelmakers. For Rio Tinto, the deal will boost profits and help it fend off BHP or force BHP to boost its takeover offer. After months of negotiating with China's top steelmakers, miners Rio Tinto PLC and BHP Billiton Ltd. won an 85% increase in the benchmark price for iron ore, a major ingredient of steel, indicating that steel prices world-wide are likely to stay high and fanning further concerns about inflation. The price increase, which tops the amount that Brazilian rival Cia. Vale Do Rio Doce received, is retroactive to April, meaning steelmakers that purchased iron ore from BHP and Rio Tinto will have to write a check for the difference, which is likely to be in the billions of U.S. dollars. The deal was settled between the miners and Baosteel Group Co., China's largest steelmaker, but it generally applies to all steelmakers that buy iron ore from the two. Prices for steel across the globe have been rising dramatically, doubling in some cases, as costs of iron ore, coal and other raw materials have increased. A backlash by steel buyers, especially those in construction materials, is getting stronger. Some countries are increasing export taxes to encourage local cheap steel to stay at home, while other countries, such as Turkey, Italy, India and Russia are staging protests and work stoppages and passing legislation that freezes steel prices.