Well with last week's GDP release and today's Employment numbers it seems like a good time to dive into the painful economic data. Which, despite the Street's blowing it off, is about as bad as you think it is. In some ways, and more importantly, it's not just US data we need to pay attention. After listening to a bunch of the Davos sessions online we need to pay attention to a lot more: the world economic situation and outlook for one thing. For example the IMF just issued revised world outlooks, and that's after dropping them severely in Nov. after the regular Oct. release, they're anticipating worldwide growth this year of 0.5% ! With risks mounting and assuming worldwide efforts to repair the credit mechanisms AND stimulate all the economies. Much more importantly are a couple of other factors that were very clearly highlighted at Davos: 1) the rest of the world is getting hurt worse than the US, 2) the necessary institutions aren't in good shape in comparison and are coming increasing strains, 3) there is a building backlash from various populations that that threaten those institutions and 4) the likelihood of serious socio-political instabilities is rising rapidly. If this all comes to pass don't say you weren't given a major heads up - though unfortunately outside of Davos there doesn't seem to be much attention being paid. The bottom line here is that our own domestic economic problems may in fact be the least of our worries.
US Domestic Economic Situation
Let's start by looking at the domestic economy with this composite three-part chart - which we had to extend back to '60/'65 so you could see how bad it's getting; and hopefully just by eye-balling the charts can see where it's headed. Dr. Doom II, Nouriel Roubini, has a pretty strong case. The top part shows YoY changes in real GDP, Consumption and Retail Sales. Think of Sales as the ugly, diseases 800 lb. canary because it's dropped more than at any time since 1960. How's that for loud chirping ? The second chart shows one of our favorite indicators - the sum of the change in Real Wages and Employment. Which, as you can see, has been a superb leading indicator of changes in Consumption. Since the economy is 71% consumption that's the engine that drives everything else. The small ray of light is that W+E actually upticked a bit as the result of the drop in inflation caused by the drop in oil prices. The bad news, which you can see in the third part, is that it's a developing race between Employment declines and real wage increase. With the latter not to get much better while the former will continue to deteriorate big time. In fact employment is a lagging variable and is likely to get worse for the next 18 months, thereby swamping any positive benefits from wages. Which are also likely to start dropping. The conclusion - this is the worst downturn we've seen since the end of WW2 and it's headed further South before it bottoms out. You'd better hope that stimulus package passes and it works.
World Economic Outlook
Shifting gears let's look at the IMB World Economic Outlook. As you can see the Developed economies have actually been performing poorly for some time but now the impacts are being felt in the Developing ones as well. Even with the admittedly optimistic outlook for 2010 world growth is not projected to get any more than 3% at best in '10. An outlook which the IMF admits is full of downside risk. The Developing economies are expected to pull out 5.5% at best as a result. That varies by country and if you're curious about any one in particular you can go to the IMF web site and use their online Data Mapper to dig into their outlooks - which go out to 2013. As we discussed in an earlier post (Re-coupled Vengence: From Downturn to Implosion Risks ?) they are far from sanguine. In that post you'll find the IMF address plus charts out to 2013 AND a discussion of the geo-poitical risk factors which are escalating as we sit here !
Risk Factors
One of the sessions was on risk factors and management and it was one of the best, if bluntest, we listened to. A key chart from the report is shown at right and makes interesting browsing, calling for careful attention. The chart maps severity vs. likelihood and covers a wide variety of risks from economic to geo-political to environmental. We were amused to see, despite all the rhetoric, that global warning is serious but well down the list on both dimensions. Not a laughing matter at all are the top two clusters. In fact the most severe risk is the continuing risk of asset price collapses - when we keep talking about the threat to Western Civilization it turns out that we weren't kidding and a very high-powered team agrees (btw their session URL is in the readings - we highly recommend watching it, preferably strong drink in hand). Interestingly in light of our prior comments the other two biggest risks are a jump in energy prices if/when the economy recovers (because of under-investment ( Oil Industry II(Analysis): LT Supply-Demand, Outlook and Disruptions,New (Old ?) Frontiers in the Oil Markets: the Return of Geo-Politics)) and escalating protectionism in the developed world, though protectionism in the developing world is also a serious risk as well. Like we said institutional support for this world crisis doesn't exist, another major theme heard in almost every session. The upcoming G-20 session in April is mission-critical. Almost as fascinating the next cluster of serious risks a rapidly slowing Chinese economy, threats to the world food supply and widespread fiscal crisii ! Brace yourselves - let's hope it turns out only as bad as it looks and not as bad as it could be. We're so far beyond decoupling or even recoupling and into a vicious feedback loop that could bring a lot of things down.
Readings
The readings excerpts are broken up into three sections - the first contains readings on the US and World economic outlook, an extract from the Risk Report which'll take you to the whole thing (the executive summary is well worth a second drink or three at least) and StratFor's latest take on Russia's strategic objective. In this close-coupled world we need everybody to act as responsible stakeholders, which the Japanese and Chinese are doing, as well as the Europeans. The Russians appear to be playing by the old rules, which is particularly sad given the evolving death symptoms of their socionomy. Unfortunately (how sad to have to say that and mean it !) not in enough time to prevent their disrupting the world system, particularly in Central Asia, as their recent actions with regard to the Kyrgyzstan air-field show.
The second section surveys the US institutional responses from Round III of the financial rescue packages which Sec. Geithner is beavering away as we talk, to some dissections of the poitical status and technical content of the stimulus package (there's a URL link to a recent Rose interview with Leonhardt, Welch, Feldstein, etc. we highly recommend). And the final section surveys and samples what's going on around the world, including examples of other countries putting their own massive stimulii in place. Unfortuantely, and not thru necessarily deliberate policy, the protectionist drawbridges are being drawn up by the financial crisis. Which in turn has emasculated worldwide investment flows, badly damaged the developing world and that will, in turn reflect back on the developed world. Welcome to coupling with a vengence !
Geonomic Situation: US and World
UPS Woes Reflect Wide Economic Slump United Parcel Service Inc.'s grim fourth-quarter earnings report Tuesday offered the latest evidence of a slumping global economy that is exacting harsh punishment on virtually every company that moves goods, from ocean shipping lines to railroads to parcel-delivery companies. UPS's average daily domestic volumes were down 2.8% for the quarter, including an 8.6% drop in its premium next-day-air service. With volumes and profits down markedly, UPS, the world's largest package-delivery company, presented a dour outlook similar to companies shipping everything from auto parts made in Detroit to sneakers made in China. "We don't know when it's going to turn around," Chief Executive Officer D. Scott Davis said Tuesday during a conference call with investors. UPS will operate under the assumption that "it's going to stay down for all of 2009," Mr. Davis said. The company declined to offer full-year earnings predictions for 2009, citing the uncertain economy. The UPS results reflect the decline of shipping across the economy. Trucking tonnage dropped 6% for the fourth quarter of 2008 over the same period in 2007, according to the American Trucking Associations. In December, North American railroad volumes dropped 15.2% compared to the same month in 2007, according to the Association of American Railroads. UPS said Tuesday that it will freeze salaries for some 35,000 management-level employees and suspend its contributions to employee 401(k) retirement plans for an even larger number of workers. If UPS is suffering, so are the businesses that hire it to deliver their packages and freight. A big UPS customer, Harry & David Holdings Inc., the mail-order gifts conglomerate, said in January that it was reducing its staff by 10% in the face of slumping sales. A Harry & David spokesman said the company uses UPS to ship "90 percent plus" of its packages.
World Growth Grinds to Virtual Halt, IMF Urges Decisive Global Policy Response World growth is forecast to fall to its lowest level since World War II, with financial markets remaining under stress and the global economy taking a sharp turn for the worse, sending both global output and trade plummeting, the IMF said in its latest assessment of the world economy. "We now expect the global economy to come to a virtual halt," said IMF Chief Economist Olivier Blanchard in prepared remarks for a press briefing. World growth is projected to fall to just ½ percent in 2009, its lowest rate in 60 years, the IMF said in an Update to its World Economic Outlook, released on January 28 together with an update to its Global Financial Stability Report. For projections, see table below. Despite wide-ranging policy actions by governments and central banks around the world, financial strains remain acute, pulling down the real economy. The Update echoed comments by IMF Managing Director Dominique Strauss-Kahn that a sustained economic recovery will not be possible until the banking sector is restructured and credit markets are unclogged. "For this purpose, new policy initiatives are needed to produce credible loan loss recognition; sort financial companies according to their medium-run viability; and provide public support to viable institutions by injecting capital, and carving out bad assets, including possibly through a "bad bank" approach," the Update stressed. "We think that more decisive action is needed now by both policymakers and market participants, and with greater emphasis on balance sheet cleansing," said Jaime Caruana, Financial Counsellor of the IMF. The IMF has raised its estimate of the potential deterioration in U.S. originated credit assets held by banks and others from $1.4 trillion last October to $2.2 trillion now [see related story]. Monetary and fiscal policies need to become even more supportive of aggregate demand and sustain this stance over the foreseeable future, while developing strategies to ensure long-term fiscal sustainability. Moreover, international cooperation will be critical in designing and implementing these policies in order to avoid destabilizing distortions.
Global Risks 2009 2008 was an historic year. Financial disruptions triggered by declining house prices in the US grew into a global credit crisis of systemic proportions. By the second half of the year, most advanced economies had entered a recession. The downturn spilled over into emerging markets, increasing the likelihood of a global contraction in 2009. Although the world has seen several financial crises, this one differs in two respects. First, it has demonstrated just how tightly interconnected globalization has made the world and its systems. Second, this crisis was driven by developed economies using unprecedented levels of debt and leverage throughout the financial system. Thus, risks that had been identified in the past two editions of this report – the risk of a global meltdown in asset prices (2007) and the widespread mispricing of risk and the potential implications of systemic financial risk (2008) – have materialized with huge consequences. This year’s report focuses on the effects of the global financial crisis and its implications for those risks that came to the fore of the Global Risk Network assessment for 2009. They include: a sudden further drop in China’s growth to 6% or below; deteriorating fiscal positions; further asset price falls; increasing resource-related risks due to climate change; and the failure of global governance to mitigate global risks. The highly interconnected nature of these risks means that their impact is truly global. The economic outlook for 2009 is a grim one for most economies; markets remain volatile, liquidity has not returned, unemployment is rising, and consumer and business confidence has fallen to record lows. In this climate, risks become even more potent in their impact and, as discussed in previous reports, the tendency towards panic and short-term responses are more pronounced. This report explores the dangers of managing out of this crisis, without considering the broader, long-term consequences of today’s decisions. It also stresses the need for a determined, global focus on balancing the response to the immediate challenges with a concerted effort to mitigate longer term risks, not east those relating to climate change and resources.
Global Trend: The Russian Resurgence Russian power is in long-term decline. Compared to the Soviet Union in 1989, the Russian Federation has less than half the population, one-third the economic bulk, lower commodity production and vastly decreased industrial output. Demographically, Russia is both shrinking and aging at rates that have not been seen outside of wartime since the time of the Black Death. The educational system has stalled, so Russia is facing an impending slide in labor quantity and quality, which will make it difficult if not outright impossible for Russia to keep up with its advancing neighbors. The long-term prognosis is, at best, very poor. But "long-term" is the operative term. Russian power today must not be measured in the terms that will dominate its existence in the future. Instead, it must be assessed dispassionately in relative terms against its neighbors and competitors. Russia's primary target in 2009 is Ukraine, a country uniquely critical to Russia's geopolitical position and uniquely vulnerable to Russia's energy, intelligence and military tools — and then there is the influence Russia can wield over Ukraine's large Russian-speaking population. Russia has many other regions that it wants to bring into its fold while it can still act decisively — the Caucasus, Central Asia, the Balkans, the Baltics and Poland — but Ukraine is at the top of the list. Ukraine occupies a piece of territory that is completely integrated into Russia's agricultural, industrial, energy and transport networks. Its physical position makes it crucial to Russia's ability to project power. A Ukraine at odds with Russia constrains Russia's position in the Caucasus, limits Russian power in Europe, threatens the entire Russian core and puts Moscow within spitting distance of a hostile border. A defiant Ukraine not only forces Russia to be purely defensive, but actually makes Russian territory indefensible from the west and south, as there are no natural boundaries to hide behind. In contrast, an acquiescent Ukraine allows Russia to project power outward into Central Europe and gives Russia greater access to the Black Sea and thus the Mediterranean and outside world.
Institutional Responses
On the way: A bigger, broader bailout With Bailout I, which culminated in then-Treasury Secretary Henry Paulson's now-infamous three-page, $700 billion Troubled Asset Relief Program, clearly unable to stabilize a reeling financial system, new Treasury chief Timothy Geithner has put together Bailout II. The details await a formal announcement -- quite probably this week -- and the compromises of congressional lawmaking, but the broad scope is clear. Bailout II will be bigger. It will:
- Create a "bad bank" to own the worst of the so-called toxic assets now burning through bank balance sheets.
- Guarantee hundreds of billions more in shaky assets that banks decide to keep in their vaults.
- Help to prevent foreclosures and to reduce unsustainably large mortgage payments.
- Require more limits on CEO pay and bonuses, more visibility into how banks use taxpayer money and more disclosure of who lobbied whom to get billions for specific banks.
The one big thing we won't know, even after the last vote is cast, is whether Bailout II will work. It will embody the best thinking available on how to fix this mess, but this crisis has so far confounded the experts. Nobody can say the Obama administration hasn't hit the ground running. Even as senators were grilling Geithner in confirmation hearings over why he didn't pay the correct taxes from 2001 to 2004, the administration was laying the groundwork to win congressional and public approval for the new plan. None of this is going to be an easy sell. Taxpayers don't think the funds from Bailout I have been handled responsibly, and they're right. They don't think banks have been required to bear as much pain as they should have, given their role in creating this crisis, and they're right. They're outraged that banks that have lost billions and required billions in taxpayer bailouts are paying bonuses, and they should be. If my e-mail is any indication, taxpayers who didn't get in over their heads by buying houses they couldn't afford don't have any sympathy for those people who did, and that's understandable. Bailout II will address some of this rage. There will be tighter limits on CEO pay and a cap on bonuses, for example. I expect some of any plan to be punitive. Taxpayers and Congress need to see Wall Street and the banks punished before they vote more money for a bailout. And Bailout II will require more money. The Obama administration has access to the $300 billion to $350 billion from the Troubled Asset Relief Program's original $700 billion that hasn't been spent. But that won't be enough. The Federal Reserve and Treasury believe Bailout II will need to be capitalized at around $1 trillion. The government can get part of the way to closing the gap by leveraging its capital, but my back-of-the-envelope calculations show a need for more taxpayer money.
Real Time Econ: Expert Says Stimulus Falls Short Mark Zandi has become the de facto chief economist to Congress in recent months as the fiscal stimulus package developed, participating in numerous hearings and conference calls. Democratic lawmakers use the name of the Moody’s Economy.com chief economist — a former adviser to John McCain’s presidential campaign — repeatedly to push their case. But the package lawmakers are moving falls short of what Mr. Zandi recommends. The latest House stimulus package includes some effective provisions, such as a temporary tax cuts, he said. But other pieces don’t fit with what he’s been advocating — quick spending to boost the economy. “If I were king for the day I might define the stimulus differently,” Mr. Zandi said. “The part of it that doesn’t really fit what I was hoping for was the spendout ratio on infrastructure. The spendout ratio is slower than expected.” The structure of stimulus has been one of Republicans’ key complaints, and the Obama administration is supporting some changes in Senate legislation to get spending out sooner. Mr. Zandi also recommends using the stimulus package to address the housing turmoil through tax credits. The $7,500 tax break signed into law last summer gives first-time homebuyers a credit until July 2009 that must be paid back over 15 years — effectively making it an interest-free loan. Instead, Mr. Zandi says, making it payable at the time of a home’s sale would allow it to be used for downpayments and could spur more housing activity. A frequent expert witness at congressional hearings and omnipresent in news coverage, Mr. Zandi has become the most vocal economist arguing for a major fiscal stimulus package. The biggest risk today, he says, is “people not having clear sense of the severity of the recession.” “I feel strongly about stimulus. I feel it’s absolutely vital,” he said. “It’ll make all the difference between recession and depression.” Mr. Zandi argued for years the benefits of fiscal stimulus to boost a sagging economy, and his firm’s multipliers — showing the stimulative effect of spending, tax cuts and other measures — are widely cited by lawmakers and outside advocacy groups. He supported the taxpayer rebates in early 2008 and says the criticism that it didn’t work is wrong. Higher-income households were already ramping up saving and pulling back just when the stimulus hit. “If the rebate wasn’t mailed, retail sales would’ve been hammered long before they started to fall,” he said.
Your 5-point economic rescue guide The stakes for a mega-billion-dollar stimulus package are enormous. Here's how to make sense of a complicated and confusing debate. Will it work? Will the stimulus package now being yammered out by the House and the Senate actually pull the economy out of recession? The good news is that stimulus packages can work. Even better, we've got lots of experience with what doesn't work. The bad news is that we don't know very much about how much size matters. Huge packages clearly work. Small packages clearly fail. But we don't know much about where to draw the line. And we don't know much about how to get the maximum bang for our buck. The truth is that just as what John Maynard Keynes called "animal spirits" play a huge roll in starting a recession, so, too, do emotions determine when a recession will peak and end. Most economic policy -- and most economic theory -- is built on an assumption that human beings behave rationally. Good luck with spending money effectively on that foundation. So what do we know about whether the stimulus package will work? Here's my five-point guide to the good, the bad and the ugly of economic rescues: The New Deal's lack of success in reducing unemployment from 1936 to 1940 wasn't because deficit spending and economic stimulus had failed as policies but because the Roosevelt administration had rolled back its stimulus program. If you want to see stimulus at work, I'd say look not at Roosevelt's second term but at World War II. 3. Economic stimulus packages don't work if they're small, slow or inconsistent. How do we know this? The Japanese ran exactly that kind of stimulus effort in the 1990s, and it was a dismal failure.
At Madoff Hearing, Lawmakers Lay Into S.E.C. Securities regulators could not cool the white-hot Congressional fury on Wednesday over their failure to act on tips that might have exposed the Madoff scandal almost a decade ago. At a contentious hearing by a House Financial Services subcommittee, Harry Markopolos, a private fraud investigator from Boston, detailed his persistent but futile efforts to spur the Securities and Exchange Commission to investigate Bernard L. Madoff, going back to 1999. Mr. Madoff was arrested in December and charged with running a giant Ponzi scheme — the very accusation Mr. Markopolos said he made repeatedly to S.E.C. employees in Boston and New York to no avail. Lawmakers spent the rest of the hearing in a heated dialogue with senior S.E.C. staff members, getting little satisfaction and suggesting the agency was the problem. In the torrent of criticism that Mr. Markopolos and lawmakers heaped on the S.E.C. and its senior staff members, some complaints were serious — that the agency lacked the expertise to tackle major frauds by big players and had no systematic way of dealing with whistle-blowers. Others were sarcastic, with Mr. Markopolos saying regulators seated in Fenway Park in Boston would have trouble finding first base. The agency’s officials repeatedly tried to explain that they could not discuss the handling of the Madoff case without jeopardizing that pending investigation — and were repeatedly cut off by lawmakers who demanded specific information about the handling of the case. Representative Paul E. Kanjorski, Democrat of Pennsylvania and the hearing chairman, criticized the official position as an expression of arrogance that he said was at the root of the agency’s regulatory failures. Congress is in the midst of creating regulatory changes that could change the agency’s fate, Mr. Kanjorski warned the panel of official witnesses. Lawmakers want immediate candor about the handling of the Madoff matter, not generalities, he said. But the hearing became a collision of frustrations that, at one point, prompted Mr. Kanjorski to accuse the staff members of refusing to cooperate with a branch of government that could wipe their entire agency off the regulatory map, if necessary. Representative Gary L. Ackerman, Democrat of New York, was more blunt in his condemnation of the S.E.C. officials sitting before him: “We thought the enemy was Mr. Madoff. I think it is you.”
World Responses and Adjustments
Homeward bound A great financial retrenchment is under way, the product of both market forces and political pressure on banks to lend at home rather than abroad. AT THE annual pilgrimage to Davos last month, politicians were united in agreement: the biggest danger facing the world economy is protectionism. Many of the mountaintop sermons picked out the risk of financial mercantilism, a reflux of capital from foreign markets to home ones. Gordon Brown, Britain’s prime minister, preached against a “retreat into domestic lending and domestic financial markets”. But back in the real world the barriers to the free flow of capital are rising fast. Are the politicians hypocrites, toothless or misguided? A bit of all three. That a retrenchment in cross-border credit is under way is beyond doubt. In Mr Brown’s Britain, data from the Bank of England show that in the fourth quarter of 2008 local banks sharply cut lending to foreign customers. British borrowers are themselves suffering from the withdrawal of Icelandic, Irish and other foreign lenders, which provided a big chunk of their credit at the peak of the bubble. The Australian government is creating a A$4 billion ($2.6 billion) fund to tide over commercial-property investors who cannot renew foreign debt. Corporate borrowers in many markets are about to put their foreign bank creditors to the test, as they prepare to refinance. Changes there will be, thanks largely to the failure of Iceland’s banks last year. Their implosion, after years of rapid expansion abroad, rammed home the unpleasant truth that banks may be global in life but are national in death. Depositors in other countries, who were entitled to compensation from the Icelandic deposit-insurance fund, found that the pot in Reykjavik was too small to pay them when the banks went bust. Their own governments had to step in. “It is hard to overstate the damage that Iceland did to the trust among regulators,” says Bob Penn of Allen & Overy, a law firm. “It made real problems that until then had only existed in theory.”
In Shift, Chinese Move More Money Overseas More money is moving in a new direction in China — out. Some Chinese are so eager to turn their yuan into other assets that when an online real estate brokerage organized a tour of foreclosure auctions in the United States, it received so many applications that it had to turn away nearly 400 people. In Shanghai, cash-rich Chinese companies are buying high-yield bonds issued by distressed American companies at a time when many Western investors are steering clear of bonds even from solid companies. All over the world, Chinese companies are sending home fewer of the billions of dollars they earn from exports, parking them in overseas bank and brokerage accounts instead. Together, these trends represent a potentially tectonic shift. As Chinese citizens are starting to send more money out of the country, foreign investors are pulling money out too, and slowing the pace of new investment. Nobody knows how long this trend will last. If China’s series of economic stimulus measures are successful, then the Chinese economy could rebound later this year and start drawing back money on the same scale that it did over the last decade. Total outflows in the fourth quarter were as much as $240 billion, but this is using the broadest possible definition and includes everything from capital flight to a slowdown in repatriation of overseas profits by Chinese companies. There is no good data assessing the motives of those moving money out of China. Most troubling for China would be if a sizable portion of these disparate streams represented capital flight — people taking their money out because they worry about the stability of the country. Though there are myriad reasons to move capital around, there is also cause for concern: Chinese authorities announced Monday that 20 million migrant workers had lost their jobs. If they do not find new work, these workers could form a volatile class of unemployed. Even more crucial, Chinese individuals and companies placing more of their money outside China could affect one of the constants of international finance over the last five years: China’s central role in bankrolling American trade and budget deficits. To prevent China’s currency, the yuan, from rising, the government has been buying up the dollars pouring into the country from trade and foreign investment, accumulating more foreign exchange reserves than Japan, Saudi Arabia and Russia put together. It has paid for the dollars by printing more yuan, and has invested at least two-thirds of the dollars in American securities, particularly Treasury securities. If considerably fewer dollars come in, China will not have the yuan to continue buying vast amounts of Treasuries, assuming it wants to keep buying them.
Australia and Japan Offer New Stimulus Plans Australia announced a $26.5 billion stimulus plan and an interest rate cut on Tuesday and the Japanese central bank said it would start buying shares held by beleaguered banks, the latest examples of stimulus measures in response to a deepening recession. In Japan alone, tens of thousands of job cuts have been announced in the last two weeks, and in China some 20 million of the country’s 120 million migrant workers are thought to have lost their jobs. The export-driven economies of Asia countries have been hit particularly hard in recent weeks as demand from Europe and the United States has collapsed. “Things will remain very challenging for some time,” said Patrick Bennett, foreign exchange and rate strategist with Société Generale in Hong Kong. “Recent trade figures from South Korea, for example, are evidence of a marked slowdown in global activity,” Mr. Bennett said. “The old consensus that there might be some improvement in the second half of this year is looking increasingly optimistic.”More stimulus add-ons are widely expected as the recession drags on. China, which announced a package of infrastructure spending and other measures last November, is widely expected to announce fresh steps to bolster growth and safeguard jobs in the weeks ahead. And central banks in the eurozone and Britain are expected to continue their string of interest rate cuts in a bid to pull those economies out of recession. In Japan, where rates are already near zero, the Bank of Japan is relying on other tools — like buying commercial paper, a type of short-term debt — in an attempt to ease credit conditions and get banks lending again
Firms' Bleak Prospects Add Pressure in China A string of dire profit warnings has signaled a rapid deterioration in the financial health of Chinese companies on which the world's third-biggest economy heavily depends, putting more pressure on the government to enhance its stimulus efforts. Corporate investment is hugely important to China's economy, where capital spending accounts for more than 40% of annual output, one of the highest ratios in the world. The profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses. Weaker private-sector investment means China's growth this year will be more dependent on the success of the government's big spending plans. The profit warnings are coming weeks ahead of China's official corporate reporting season, as companies are required to give advance notice of particularly big swings in profits. Official surveys back up the trend. Profits of industrial companies plunged 27% in the three months to November, according to government statistics, a sharp reversal from a years-long string of 20% to 40% growth. Economists have long warned that Chinese companies' heavy reliance on retained profits would tend to exaggerate swings in the nation's investment cycle. Official statistics show that 63% of investment in China last year was financed by what are called "internally generated" funds, which include retained profits. That's up from just below 50% a decade ago. During boom times, high profits get plowed back into new projects -- evidenced by the plethora of shiny new corporate headquarters that dot big cities such as Beijing and Shanghai. Now, some of those investments don't look as smart, and shrinking profits are making it more difficult for companies to fund different ones. Avoiding that boom-bust cycle was one reason why organizations such as the World Bank had argued that China's government should collect dividends from the companies it owns, which include most of the country's biggest corporations. From the late 1990s, the government allowed state companies to retain all their profits. But a dividend system was put in place by early 2008. Programs financed from those payments had a budget last year of 54.78 billion yuan. That suggests the companies owned by the central government are paying average dividends of 7% to 8% of their profits. The expected downturn in corporate investment this year is one reason many investors are skeptical about the effectiveness of the Chinese government's four trillion yuan stimulus plan announced in November, which depends in part on corporate spending.
Russia Faces Tough Fight on Ruble Russia has vowed to put a floor under the beleaguered ruble. It may have painted a bull's-eye on the currency instead. Pressure on the ruble is likely to mount in coming weeks, say investors and analysts. Many predict a gloves-off battle between investors intent on driving the currency lower to reap profits, and Moscow, which may be forced to make unpleasant choices to keep the ruble from falling. Already, sellers ranging from foreign investors to local companies have driven the ruble to within a hairsbreadth of the central bank's new limit, announced just two weeks ago. The tumble comes despite higher interest rates and steps to limit the supply of rubles. The Russian authorities "set themselves a line in the sand, and we've approached it very rapidly," says James Malcolm, a currency strategist at Deutsche Bank in London. "It's an irresistible target." The exchange rate is a highly sensitive issue in Russia, where memories of the 1998 ruble collapse remain fresh. The currency's drastic reversal over the past few months -- hammered by the plunge in the price of oil, Russia's main export, and a torrent of capital fleeing the country amid the global crisis -- has put the Kremlin on the defensive.
