Dr. John Rutledge Blog

September 27, 2006

August New Residential Sales

(Greenwich, 9/27/2006) Sales of new one-family houses in August 2006 were at a seasonally adjusted annual rate of 1,050,000, according today's U.S. Census Bureau/HUD New Residential Sales in August, 2006 Report. This is 4.1% above July but 17.4% below August 2005. The median sales price of new houses sold in August 2006 was $237,000, just under its $240,100 level a year earlier but down 7.8% from its peak of $257,000 in April. The seasonally adjusted estimate of new houses for sale at the end of August was 568,000, 6.6 months supply at the current sales rate compared with 4.3 months supply a year ago.

JR

Posted by John Rutledge at 10:39 PM | Comments (2)

August Durable Goods

(Greenwich, 9/27/2006) New orders for manufactured durable goods in August 2006 decreased 0.5%, to $209.7 billion the second consecutive monthly decrease and followed a 2.7% decrease in July. Orders were up 8.5% over year earlier figures. You can see the report by clicking here, then clicking the red Advance Report on Durable goods title.

Manufactured durable shipments increased 1.9%, to $214.2 billion, its highest level since 1992 and 7.6% above a year earlier. Capital goods shipments rose 1.4% in August, 11% higher than a year ago.

Unfilled orders increased $2.4 billion, or 0.4%, to $631.9 billion, up fifteen of the last sixteen months. This is the highest level since the series began. Inventories rose 0.2%, to $287.1 billion.

Communications equipment was a bright spot, with orders up 7.0% in August (+13.8% year over year) and shipments up 4.7% in August (+5.8% year over year.)

Motor vehicles and parts orders continued their see-saw, up big for the onth after a terrible July but only 0.5% for the year. Shipments for the year were 0.0%.

Taken as a whole the report gives a soft picture of growth, which will help keep interest rates down and support firming multiples in the stock market.

JR

Posted by John Rutledge at 10:00 PM | Comments (1)

Middle Market Private Equity

(Greenwich, 9/27/2006) My partner Rob Tucker confirmed today there is a wall of money chasing a shrinking pool of deals in the middle market for private equity transactions. Banks, mezzanine lenders, and equity investors are all trying to get money to work. A business that would have sold for 4.5 times trailing 12 month EBITDA, or cash flow, 5 years ago is now trading at 7.5 times. At those prices an equity investor selling the business at the same multiple 5 years from now would earn high teens returns even it the company hits its business plan. Mezzanine lenders would earn 12-14%.

This chart shows Thompson Financial data for average transaction multiples by size of deal, with prices ranging up to 9 times cash flow for over $100 million deals. TAggressive lending is driving the high prices.

Transactions are now being done with total debt levels of almost 5 times cash flow and senior debt over 4 times cash flow. Both numbers are as high or higher than anything we saw at the peak of the last buying binge in 1999 and early 2000. Although there are rumors of credit officers asking questions about companies having a hard time meeeting aggressive plans there is no sign yet of a pullback by lenders.

On Larry Kudlow's show Tuesday night we had a spirited debate with several guests who were ready to declare a recession. I see no signs of recession yet. But I knnow how to create one if you would like me to do so. Recessions happen when credit markets shift from being cleared by market prices and being cleared by non-price rationing. that happens when there is a sudden deterioration in collateral values for existing loans (as in 1989-92 when land prices fell for the first time since the 1930s) or in the cash flow levels specified in loan documents or when the order goes out from central command (the Treasury or Fed) to stop lending (as in 2001-2004). these conditions create a temporary 'blackout' in credit markets during which it is difficult to get credit at any price. We should keep our eye on private equity loans and real estate loans as potential sources of a blackout.

JR

Posted by John Rutledge at 9:21 PM | Comments (2)

Falling Marginal Tax Rate in France

(Greenwich, 9/27/2006) Interesting piece in Le Figaro today on falling marginal tax rates in France from 50% in 2003 to 40% ne3xt year. The French economy is growing again. Hmmm. I wonder if there is a connection. Keep cutting mes amis. You will like it.

JR

Posted by John Rutledge at 7:32 PM

The Internet is Hard to Control

(Greenwich, 9/27/2006) With PCs and mobile phones everywhere and widely available broadband networks China's Internet and information market are really taking off. Thought you would like to see this article from today's Shanghai Daily on the ongoing attempt to adjust regulations on communications so they are actually enforceable. With today's technology, controlling informatioonis like trying to stop the sea by holding up your hand. Shanghai Daily.

JR

Chongqing Internet users no need to register 2006-09-27 THE Standing Committee of the Chongqing People's Congress deleted the article in a new regulation that requiring all individuals to register with the police in 30 days after their network is connected, or their connection will be shut down for as long as six months, Chongqing Evening News reported today.

The committee revised the draft of Internet security regulation during its second revision, saying that only the Internet access providers, information service institutes and companies that operate local area networks need to register at public security departments.

The former proposal suggested that individual Internet users entrust their Internet service providers, such as China Telecom, China Unicom or China Netcom, to register for them by providing these operators with their personal information.

The practice was meant to enhance the management and supervision of Internet surfing and to crack down on online crimes, which have been increasing by thousands countrywide per year, and earlier report said.

Posted by John Rutledge at 6:56 PM | Comments (1)

Credit Cards in China

(Greenwich, 9/27/2006) As I have written before, China is working toward fully opening its capital markets to foreign firms by the end of this year in accord with the WTO agreement. US firms are lining up at the border like the Oklahoma land rush to get at China's huge, growing market.

Today, most transactions in China are handled using cash, sometimes thick stacks of 100 RMB notes. There is a huge opportunity to bring credit cards to China. There is also a lot of work to do to create the necessary credit history data bases and risk measurement and management systems. There will also be a period during which China's consumers will learn how to manage credit.

Thought you would like to see the charming email I received from a young woman in China on the subject.

Dr. Rutledge, it's my first time to leave comments on your blog, although I have read them several times! xixi, Maybe as a young greenhand girl on work, it's a little difficult to understand all of the economic thing, but I'm much interested. I particularly like your part on China. After reading, I can feel a kind of confidence for my motherland's future development, thank you for your analysis and support. Yeah, there always exist changes in chinese daily life. For example, recently I found so many banks began the campaign of sending credit cards toward the public. and the requirement for application is not as complicated and high as before. Even the fresh worker like me can have one or more. I wonder if it is cost-effective for me to have one and use it in my daily expense. hehe. It's pleasure to taik with you.

It is young people like this that are going to drive China's growth over the coming decades.

I am working on two aspects of the credit problem. With Hunan University I will be working on credit histories. With Haidian I am working to attract financial talent to help train and grow financial companies. This is going to be an exciting story for many years.

JR

Posted by John Rutledge at 5:18 PM | Comments (2) | TrackBack

No Exit Bonus? What's that About?

I've heard of some tough bosses but really, this is going too far. This poor young fellow in the story below left the firm after working really hard. They didn't even give him a good-bye payment. What is Greenwich coming to?!

SAN FRANCISCO (MarketWatch) -- Brian Hunter, the energy trader whose big natural-gas bets cost Amaranth Advisors LLC roughly $6 billion earlier this month, has left the firm, a person familiar with the situation said Wednesday. Amaranth has told investors in private meetings that Hunter wasn't given any termination payment, the Financial Times reported, citing unidentified people close to the matter. Amaranth, a multistrategy hedge fund that had assets of $9.2 billion at the end of August, lost $6 billion earlier this month after Hunter's massive natural-gas bets went awry.

There is a lesson in this fiasco. We have trained an entire generation of MBA students--who are now driving the bus--that you can pretty much wipe out risk with a PC, a spreadsheet, a few siple regressions, and a covariance matrix. Then, when things go wrong, it wasn't anybody's fault because the event was almost zero probability. We need to drill into students heads that correlations are, at best, transitory manifestations of collisions which further collisions will erase. They are not a suitable foundation for betting the ranch. Read Exploring Complexity, by Nicolis and Progogine to learn how disequilibriuym constraints can give rise to correlation at a distance. Read The End of Certainty to learn why the correlations don't last. Irving Fisher (a physics student of Josiah Gibbs) knew this more than 100 years ago when he described how the motion of a ship's mast, displaced by a puff of wind, will gradually converge on equilibrium, but real world ships are endlessly buffeted by subsequent gusts, keeping the mast permanently in motion. Time to learn it again.

JR

Amaranth trader leaves hedge fund after big loss: source
Marketwatch - September 27, 2006 3:36 PM ET

SAN FRANCISCO (MarketWatch) -- Brian Hunter, the energy trader whose big natural-gas bets cost Amaranth Advisors LLC roughly $6 billion earlier this month, has left the firm, a person familiar with the situation said Wednesday.

Amaranth has told investors in private meetings that Hunter wasn't given any termination payment, the Financial Times reported, citing unidentified people close to the matter.

Amaranth, a multistrategy hedge fund that had assets of $9.2 billion at the end of August, lost $6 billion earlier this month after Hunter's massive natural-gas bets went awry.

Posted by John Rutledge at 3:49 PM | Comments (1)

Forget the Slowdown Talk: State Tax Receipts Soaring

(Greenwich, 9/27/2006) Slowdown? What slowdown? Tax collections are the best metric for economic growth. You only pay them when you make money. You have to pay them or federal agents will enter your house with a gun. Not much room for statistical error there.

As you can see from the following excerpt from a Reuters story today, real state tax collections are soaring. Forget why--we can save that for another day. Strong tax receipts mean the economic n umbers will eventually be revised upward to show where the money came from--people's paychecks and gains on investments. The household employment survey shows the same thinkg. Don't buy the fears of slowing growth and falling profits. Most of all, don't forward this article to the Fed. We want them to think the economy is weak so they will stop fiddling with interest rates.

JR

Reuters - September 27, 2006 3:14 PM ET
WASHINGTON, Sept 27 (Reuters) - U.S. state tax revenue grew 4.1 percent in the second calendar quarter year-on-year after adjusting for tax changes and inflation. Personal tax receipts climbed 15.1 percent in the second quarter from a year ago while corporate tax income advanced 14.7 percent, the Nelson A. Rockefeller Institute of Government said in its report on the health of state finances released today. Sales tax receipts gained 5.7 percent.

The 4.1 percent overall increase is the strongest since the second quarter of 2005 when tax revenue, net changes and inflation, rose 6.5 percent.

The second quarter marked the 11th straight quarter of overall tax revenue growth for the 50 states. Revenues rose 9.9 percent when inflation and legislated changes are not excluded.
"State tax collection strength was at odds with a slowing national economy," said the research group, which is part of the State University of New York in Albany. "One explanation ... is that final (tax) payments in April (on 2005 income) were strong and that estimated payments in April and June were also strong."

Furthermore, capital gains and bonuses may have boosted tax revenue more so than underlying economic strength, the group added.

The second calendar quarter marks the end of the fiscal year for most states. Many states collected more tax receipts than they had previously projected and ran budget surpluses.

Posted by John Rutledge at 3:36 PM | Comments (3)

September 25, 2006

Chinese ESOPS--CSOPS?

(Greenwich, 9/25/2006) While we are whining about stock option scandals and tying magers up in Sarbanes-Oxley knots Chinese companies are discovering the magic of incentives. Bank of China (BOC) and China Construction Bank (CCB), two of China's top four commercial banks, will initiate employee stock ownership plans this year as part of their employee incentive programmes. BOC's shareholders already approved a stock appreciation rights policy for the management team (secret code for stock options). Regulators support the idea. You can read the story by clicking here.

According to a CCB press release:

The implementation of such plans is to increase the bank's cohesion, to harmonize benefits for employees and shareholders, and to reduce the bank's operational risks. We expect to build up our core competitiveness by attracting more talent and improving innovation through the employee incentive programmes.

Sound fammiliar?

CCB will allow its employees to hold 1 to 2 per cent of its total shares, which means each staff member will be able to buy 52,000 yuan (US$6,500) worth of stocks on average, according to the bank's current market value on the Hong Kong stock exchange. The 300,000 employees will be able to hold around 4.5 billion shares, with a total market value of HK$15 billion (US$1.95 billion).

In May, Zhou Xiaochuan, governor of the People's Bank of China, encouraged State-owned financial institutions to adopt employee stock ownership plans for the first time. "The employee stock ownership plan is an important part of financial institutions' joint stock reform," Zhou said earlier.

JR

Posted by John Rutledge at 7:01 PM | Comments (3)

Wanyuanhu, Chinese Word for 10,000-aire, Now Obsolete

(Greenwich, 9/25/2006) This piece is for the closet philologists out there. The Peoples Daily Online website is running an interesting series of articles called 49 obsolete Chinese words that tracks changes in the Chinese language. Here is one from yesderday:

Wanyuanhu: disappeared in 1997. The Chinese phrase "wanyuanhu" means a household whose annual income exceeds 10,000 yuan. In the early 1980s, the average household income was very low in China. Then, a wanyuanhu was considered very rich in both rural and urban areas. Owing to rapid economic growth in the 1990s, the standard of living has improved significantly. In 1997, the average annual income of a rural household surpassed 10,000 yuan according to national statistics. Every household has become a wanyuanhu. This was no longer considered a high standard of living and so the phrase became outdated.

Lifting vast numbers of people out of poverty is one of the truly great stories of our time. Thought you would like to see a story with a happy ending for a change.

JR

Posted by John Rutledge at 6:46 PM

Home Prices Down for Full Year--First Time in 11 Years

(Greenwich, 9/25/2006) The median sales prices of existing homes fell 1.7% in August from year-ago levels, the first full year decline in 11 years. This is the second largest decline in the 38 year history of the National Association of Realtors survey. You can read the press release by clicking here here.or review the data by clicking clicking here.

Sales of existing homes fell 0.5% in August to 6.30 million (annual rate), the fifth straight month of falling sales but were 12.6% below year ago levels.

You ain't seen nothing yet. Home sellers are stubborn; they don't like to admit their home is declining in value. So when demand drops the first thing we see is a drop in transactions. Only later do prices fall under the weight of rising inventories of unsold homes.

Inventories are building up like thunderheads on a summer afternoon. In August there were 3.92 million homes (7.5 months supply) for sale, up 1.5% over July. Inventories are 76% higher today than they were in 2004 (2.2 million units, 4.1 months supply) at the peak of the property boom.

The eye of the storm is condos and coops, with 8.6 months supply (568,000 units) homes listed for sale, more than twice the 274,000 units listed for sale in 2004, and a gusher of new supply still under construction, especially in the west where units sold have dropped 24.8% and prices have declined 6.5% from year ago levels.

Single-family home prices fell by 2.2% in August and were 1.7% lower than a year ago. The biggest damage was in the Northeast (Wall Street bonuses?) where prices fell 2.9% in august ands were 5.5% lower than a year earlier.

The growth-haters on Wall Street, of course, loved the report. They reason that falling home prices will convince the Fed to back off. They are right. I am sticking by what I told you 6 months ago. The 10 year Treasury will finish the year below--it looks like well below--5%. And the yield curve will revert to its normal upward slope early next year when the Fed is forced to lower the Fed funds rate to less than 5% to protect growth.

What does this mean for stocks? The duration (the weighted average maturity of the present value of the free cash flows) of the S&P 400 Industrial companies is about 25 years. That means each 100 basis point drop in the 10 year Treasury adds 25% to the intrinsic value of the index. Profits are at an all-time high as a percentage of GDP, still rising at more than 15% per year.

This is a great time to own equities.

JR

Posted by John Rutledge at 11:14 AM | Comments (1)

September 23, 2006

Censorship is Censorship

(Greenwich, 9/23/2006) I grew up in a small town in Illinois entirely without the benefit of federal government indecency regulations. We didn't have laws against pornography or FCC commissioners ruling just exactly how much of a certain person's left breast we can watch on Super Bowl Sunday. What we had was an understanding. If you show what I determine to be pornographic material to my child I will come to your house and kick your ass.

Worked pretty well for the most part.

I am very, very, very much opposed to government officials interfering with free speech. If you want to know why read the history of the 20th century, when more than 100 million people were killed by their own governments. I like my government small and inobtrusive. Even in the area of "indecency." I do not want government employees decidig what my children can see. I will handle that, thank you.

My friend Adam Thierer from the Progress and Freedom Foundation said this more elegantly than I hav done in the piece he filed at the FCC on the subject. In his paper, Adam describes all the tools parents have now to manage the issue. You can read Adam's paper by clicking here.

I expect to see a lot more social and family meddling coming out of Washington in the coming weeks as the mid-term election draws near.

JR

Posted by John Rutledge at 2:11 PM | Comments (1)

June Employee Compensation Report

(Greenwich, 9/23/2006) The Bureau of Labor Statistics (where you can get all sorts of cool economic data by clicking here) has released their report on Employer Costs for Employee Compensation for June, 2006.

Data watchers pay attention to this report because they know that the Fed is data-driven, waiting impatiently by the mail room to interpret each new piece of data as it poops out of the government data mills. And they know the Fed (erroneously) believes that wage increases cause inflation. Personally, I have never understood how anyone can get excited about a report that comes out on September 22 telling you what wages were three months ago. Weren't they there? weren't they paying attention?

This report tells us that total employer costs for employee compensation for nonfarm private and state and local government workers averaged $26.86 per hour worked. Wages and salaries made up $18.80 (70%) of the figure; benefits, $8.06 per hour, accounted for the remaining 30 percent.

Costs for legally required benefits, including Social Security, Medicare, unemployment insurance, and workers‚ compensation, averaged $2.17 per hour (8.1 percent of total compensation). Employer costs for life, health, and disability insurance benefits averaged $2.19 (8.1 percent); paid leave benefits (vacations, holidays, sick leave, and other leave) averaged $1.88 (7.0 percent); and retirement and savings benefits averaged $1.15 (4.3 percent) per hour worked.

Interestingly, private industry employer compensation costs averaged $25.16 per hour worked, i.e., government employees make more money that people who actually produce goods and services. Shocking!

Looking ast the breakdown by sector we find that Management, business, and financial workers ($49.62) earned the highest total compensation, followed by teachers ($47.77), and registered nurses ($41.32). At the bottom were office and administrative support ($21.33), transportation and material moving ($20.78), and Service ($14.88). People living on the coasts earned more than people living in the middle of the country. Workers in big companies earned more than workers in small companies.

Show this report to your children.

JR

Posted by John Rutledge at 1:37 PM

China Opening Capital Markets: New Leasing Law

(Greenwich, 9/23/2006) The occasion for the conferences in China where I spoke over the past 2 weeks is China's WTO requirement to fully open its financial sector to foreign firms by the end of this year. Although there is a lot of arm wrestling going on to define "fully open" the government is making great progress. The latest advance is the new law now being considered by the National People's Congress, China's lawmaking body, to establish financial leasing firms. You can read about it in a Forbes article by clicking here.

These change are creating interesting opportunities for both foreign and Chinese companies to expand the financial service sector. I spent a lot of time with the Governors of both the Haidian District (Beijing's Silicon Valley) and Xicheng District (Beijing's financial district.) Both are committed to policies that will bring new sources of financing to China's dynamic private companies. Today, there is ample funding for large, state-owned companies but very little venture capital, growth capital, and working capital for the small and medium size enterprises (SME's) that are driving China's growth.

I am also working with Hunan University (where the Yuelu Academy, China's oldest standing universoty was founded in 978 AD), where I am a Visiting Professor in the Finance School, to help design the consumer and business credit risk measurement systems that banks will need to bring credit cards and other forms of SME financing to China. Will keep you posted on our progress.

Stay tuned for further events this fall.

JR

Posted by John Rutledge at 1:09 PM

New Law Requires Parents to Talk with Children. Cruel and Unusual Punishment?

(Greenwich, 9/23/2006) If you think our government is the only one that meddles in family issues, read this article. Parents in South China's Guangdong Province will be prodded to communicate better with their children if a provincial juvenile delinquency prevention draft is passed.

The draft, submitted on Thursday at the 26th session of the Standing Committee of Guangdong 10th People's Congress, said "parents or other custodians must frequently communicate with minors under the age of 18 in their custody."

The draft also said parents should not avoid this responsibility even if the children are living, studying or working in other places.

Yet the draft did not clarify the frequency of parent-child communication. Nor there is any mention of penalties for violating the law.

Legislators said the draft was intended to curb the rising juvenile delinquency rate, much of which stems from insufficient communication in the family.

"The parent-child relationship play a crucial role in the child's maturing process," said He Deyao, an official with the Standing Committee of Guangdong Provincial People's Congress.

He said legislators were trying to ask the parents, through an established law, "to encourage children to take part in healthy activities."

JR

Posted by John Rutledge at 1:05 PM

September 22, 2006

Chinese view of free market

(Washington, DC, 9/22/2006) Harper's Magazine reported that 74% of Chinese say the free market is "the best system on which to base the future of the world," compared with just 36% In France.

JR

Posted by John Rutledge at 2:19 PM | Comments (1) | TrackBack

September 20, 2006

Fed Policy

(New York, 9/20/2006) I did a spot about Fed Policy on Neil Cavuto's show on Fox News this evening. Here's what I talked about.

Bottom Line--It is good that the Fed stopped raising interest rates before they could do real damage to growth. It is not the rates that kill the economy, it is their impact on bank lending and credit markets. The Fed increased rates far too much over the past 2 years, which has begun to dry up lending. Ironically, we are fortunate that there was a coup in Thailand yesterday. This will make central bankers wary of creating another 1997 blowup (Thailand was the first sign of the Asian financial crisis then). Rates are going to move lower now.With a strong economy and rising profits, lower rates mean big gains in the stock market.

Monetary Base
This is the basic measure of Fed policy. When the Fed buys a T-bill the monetary base increases by exactly that amount. About 90% is held in people’s pockets as currency. The remaining 10% is held by banks as reserves. That’s the raw material for bank loans.
Increasing the monetary base is like shoveling coal into a furnace. The monetary base growth rate is the best indicator of demand growth over a long period.

The Fed has only increased monetary base by 3.2% in the past year (about half the amount that it would take to support current 6-7% GDP growth. It’s 1.1% over past 7 months—too tight. (Bank Reserves, St. Louis Fed .)

Bank Reserves
When the Fed increases the monetary base the public takes what they want to hold as currency and the banks get what is left over as reserves. Over the past year people have increased currency holdings (they are frightened by our government’s hysterical security language) so bank reserves—the stuff loans are made of— have FALLEN 1.1% (11.5% since February). Falling bank reserves will eventually shrink lending and kill the economy. Not good. (Adjusted Reserves, St. Louis Fed.)

Business Loans
After rising dramatically since May 2004, loans have flattened out since May. More than half of GDP is small business. They get their working capital from banks. If they don’t get it growth dies. (Commercial and Industrial Loans, St. Louis Fed.)

JR

Posted by John Rutledge at 7:05 PM | Comments (1)

September 19, 2006

August Producer Price Index

(Greenwich, 9/19/2006) U.S. producer prices rose 0.1% in August following increases in July and June of 0.1% and 0.5% respectively. The core rate—finished goods other than foods and energy--declined by 0.4% following July’s 0.3% drop. This is the largest drop since April 2003 and the first two-month decline since late 2002. The drop in core prices was led by a 2.6% drop in new car prices and a 3.4% decline in light motor trucks. Drug prices dropped 0.9% and alcoholic beverage prices decreased 0.9%. Energy prices saw the smallest increase since February, rising 0.3% after a 1.3% gain in July. While food prices rose 1.4% following a 0.3% decline in the previous month, consumer goods other than food and energy fell 0.5% and capital equipment prices fell 0.3%. Read the full report

This report will help Fed watchers to unclench their buttocks a little. Inflation is on the down slope now, as shown in falling metals and commodity prices. The long bond should stay right where it is, at 4.75% for the 10 year Treasury, for the rest of the year. We could even see a drop in short rates in the next several months.

JR

Posted by John Rutledge at 10:55 AM

August Housing Starts

(Greenwich, 9/19/2006) U.S. housing starts fell 6% in August to an annual rate of 1.665 million, the lowest since April 2003, according to the Commerce Department. Housing starts have fallen in six of the past seven months and have dropped 19.8% compared to August 2005. Building permits fell 2.3% to 1.722 million, the lowest since August 2002. Permits have fallen seven months in a row, down 21.9% from a year ago. Read the full report.

It's no secret to anybody now that home prices are falling. This means the only housing starts from here on will be ones that already have bullet-proof financing. Look for more weak housing numbers ahead. Good news for lower interest rates ahead.

JR

Posted by John Rutledge at 10:53 AM

August Home Builder’s Confidence Index

(Greenwich, 9/19/2006) The confidence of U.S. home builders decreased for the eighth straight month in September, falling to the lowest level since February 1991 according to the National Association of Home Builders. The NAHB/Wells Fargo housing market index dropped by three points in September to 30 from 33 in August, showing that most builders think the housing market is poor. A year ago, the index was at 65. (A reading of 50 indicates that builder sentiment was balanced between good and poor.)

By index measures, builders in all four regions of the country are pessimistic about the market. Sentiment fell by six points in the Northeast to 28. It fell by five points in the West to 38 and by three points to 38 in the South. The sentiment index held steady at 16 in the Midwest.

These charts are starting to look a lot like 1991-92 again, only this time it is all happening a lot faster thanks to the Internet and bloggers. I do not think this is going to torpedo growth, but it will make the Fed a lot more cooperative. Intereset rate increases are behind us now.

JR

Posted by John Rutledge at 10:47 AM

September 18, 2006

Forget the Renminbi, Revalue the Latte

(Greenwich, 9/18/06) You won't see this story any place else. In a terrific piece of investigative journalist I have discovered that Starbucks has devalued the Latte in China. It's a little difficult to read the type in the "steath photo" I took with my little spy camera at the Beijing Starbucks last week--I spent a lot of time there--but if you look closely you will see that the 3 cup sizes in the photo are not Venti, Grande, and Tall we are familiar with in the US but Grande, Tall, and Short. Someone has kidnapped the Venti.

The prices of the 3 sizes, translated into US dollars, were about the same as we would pay in the US which means the "per ounce" prices in China are actually higher, not lower, as many Americans believe. (using one ounce of cappuchino--defined in Wikipedia as 1/3 espresso, 1/3 steamed milk, and 1/3 foam--as the unit of account I have determined than one unit of cappuchino in Beijing is 50% more expensive (the tall/short volume ratio being 12/8=1.5) , measured in US dollars, as it is in the US.

This discovery has major implcations for global currency markets. Instead of revaluing the RMB by 25% as the US government wants, my research indicates that china should actually devalue the RMB by 50% to restore Cappuchino Purchasing Power Parity (CPPP) and correct global imbalances. I am trying to get this information to Treasury Secretary Paulson before his meetings in Beijing this week to avoid a potentially disastrous policy mistake that could have global repercussions.

JR

Posted by John Rutledge at 7:04 PM | Comments (1)

Competing for Capital

Last thing I remember
I was running for the door.
I had to find the passage back to the place I was before.
Relax said the night man
We are programmed to receive.
You can check out any time you like
But you can never leave.
(The Eagles, Hotel California.)

(Beijing, 9/16/06) Some governments get it. Some don’t. Countries are not competing for jobs today; they are competing for capital. Access to capital—modern tools, education and training, technology, and working capital— is what makes workers productive.

Capital makes paychecks possible.

Not so long ago national governments were able to count the capital within their borders as national assets to do with as they pleased. Capital was expensive to move from one country to another. Moving capital was slow, at the speed of cargo ships, easy for governments to see, tax, and regulate.

No longer. Modern communications networks and efficient capital markets have changed the rules of the game. Today, global investors can move capital from any country in the world, to any country in the world, whenever they please. These capital movements occur at the speed of light over fiber-optic networks at virtually no cost to investors. They are virtually invisible to governments.

Governments who ignore these changes in the mobility of capital do so at the peril of their workers’ paychecks.

China
I have spent the past 2 weeks in Beijing with a group of government officials who definitely get it. They are taking steps to make China a destination resort for capital. China’s leaders realize the only way to deliver continued high economic growth without further fouling the air and water and without running out of energy is to focus on IT, communications, and financial services. They are adopting policies to convince foreign investors to relocate their R&D operations in China with tax breaks, development funds, and other policies. China’s new policy mantra in China is innovation and entrepreneurship. They are doing the things to deliver on the promise.

In Beijing I spoke at 1) a venture capital forum in Haidian (Beijing’s silicon valley) to announce a new government fund to attract foreign capital, 2) the opening of a new finance school in the Xicheng, Beijing’s financial district, to train people to be employed by the foreign banks, insurance companies, investment banks, and investment managers who will open up shop after China completes its obligation to open its capital markets by the end of this year, 3) the International Financial Forum, which included talks by top Chinese officials on the importance of attracting foreign capital and a discussion of a new special enterprise zone in Tiantsin to conduct an experiment on currency convertibility, a crucial issue for investors.

Last Friday the government announced major revisions to its tax rebate system for exports. These changes reduce rebates (discourage investment) in coal, gas, steel, non-ferrous metals, wooden products and other natural resources, glass, cement, textiles, cigarette lighters, but they increase rebates (encourage investment) in biotech, pharmaceuticals, and telecommunications. And I had dinner with the executive producer of China’s hit TV show named Win in China, where 120,000 young entrepreneurs across China are competing to win 10 million RMB ($1.2M) in venture capital financing for their business plan.

U.S.
I have also spent time recently with leaders who definitely do not get it. Unfortunately, they are our leaders. In a world where countries are scrambling to attract capital—especially high-tech capital—Congress is too concerned with lobby groups, earmarked expenditures, and mid-term elections to worry about attracting and holding capital. Like Nero, they are fiddling while Rome burns, wasting their time fighting over non-issues like so-called network neutrality and deciding which snouts will enjoy the $7.3 billion Universal Service Fund trough instead of passing the communications legislation overhaul we need to drive investment and productivity higher.

Meanwhile, company after company is moving R&D facilities offshore--the share of US companies in the global telecom equipment market has fallen from 40% to 20% in the past 5 years.

Dominican Republic
Of course, it could be worse. We could be citizens of the Dominican Republic. There, Government leaders are erasing any chance their citizens have for economic growth and rising paychecks by erecting a giant sign for global investors which reads “Foreign Capital Keep Out”. Just 2 years after signing a free trade agreement with the US (DR-CAFTA), their tax authorities are attempting to gouge a $523 million payment from an American telecom company (Verizon) in violation of their own laws and international treaties.

This Hotel California tax (“You can check out any time you like. But you can never leave.”) and other investor-hostile policies (the Heritage Foundation ranks the Dominican Republic in 116th place in their Economic Freedom List) are certain to drive future would-be investors away from the Dominican Republic, a tragedy for the 9 million people who live there and who earn just $2080 per year, less than 91 other countries and only 5% of US per capita income.

Ironically, this is “Dominican Week” in New York, complete with parades and a visit from the DR President Fernandez who will give a speech about the Dominican Republic’s “business-friendly” climate. He could have saved the plane fare to New York--Investors will not be fooled. The language of global capital markets is actions, not words.

Of course, in global capital markets, one country’s loss is another country’s gain. They are cheering in the streets of Beijing.

JR

Posted by John Rutledge at 5:21 PM | Comments (0) | TrackBack

September 12, 2006

Telecom and Growth

(Beijing, 9/12/06) On September 22, I will be speaking at the U.S. Chamber of Commerce TeleCONSENSUS forum in Washington DC along with Joel Popkin. The topic is “The Telecommunications Economy: Competition and the Global Marketplace. Download file

After spending the last week in China, I can tell you that the Chinese government understands the only way to deliver high growth and increase living standards without further fouling the air and running out of energy is to focus on IT, communications, and the financial service sector. The Chinese are putting a full court press on innovation and entrepreneurship by aggressively investing in tech education and pursuing policies to attract foreign capital to relocate to China--especially such as R&D operations.

What are we doing?

JR

Posted by John Rutledge at 10:21 AM | Comments (2) | TrackBack

September 9, 2006

CCTV’s Win in China

(Beijing, 9/9/06) Yesterday I did an interview with the executive producer of CCTV’s (the Chinese National TV Network) new hit reality show called “Win in China”. It is a brilliant show. Instead of embarrassing people and voting them off islands, Win in China is a show where a selected group of Chinese students compete for venture capital funding for business plans they create during the show.

Meet CCTV Producer Sunny Lee and her colleagues on the "Win in China" interview team.

The contestants are judged by venture capital professionals—both U.S. and Chinese--and chairmen of successful companies and has strong financial support from Chinese and US businesses including Forbes, NASDAQ and Yahoo. The contestants are tested with rigorous business tasks that “test their tenacity to withstand hardship, their business acumen, and their street smarts.” The winner of the final round is selected by viewer who sent in text messages from their cell phones. The winner receives 10 million RMB in venture capital funding (about $1.2 million) plus A 20% equity stake in the NEW company. The runners up receive 5-7 million RMB in seed financing and 20% equity stakes. To encourage viewers to vote with text messages, audience members can win stock in the start-up company worth up to 10,000 RMB.

The show has been a smash hit but according to the producer Wong Li Fen, who describes the show as a cross between the Apprentice and American Idol, the focus of the show is not ratings; it is to provide inspiration to young people about “the unbeatable human spirit, determination and striving of the Chinese people.” Not a bad lesson.

JR

Posted by John Rutledge at 12:10 PM | Comments (0) | TrackBack

Haidian District Venture Capital Conference

(Beijing, 9/9/2006) Bob Mundell and I spoke Thursday at a venture capital conference in Haidian district, Beijing, where I am the Chief Advisor for Finance to the Governor. Haidian is the home of China's 2 top universities. We were knee deep in physicists. It was a great audience for me to talk about work I have been doing to apply non-equilibrium thermodynamics to issues in capital markets and economics. I will post the slide show on the blog in the next day or two.

Haidian is the “silicone valley” of China. With only 2.6 million people and 400 square kilometers in size, Haidian generates 3% of the total tax revenues for the entire country. Haidian is the home of 80 universities including Beijing and Tsinghua (#1 and #2 in China), 400,000 students, 30,000 graduate students, 100,000 private companies, 15,000 tech companies (including Lenovo, IBM and AMD) and is headquarters for 13 NASDAQ companies. As a designated high-tech zone, high-tech companies that move to Haidian pay 0% taxes for 3 years, 7.5% taxes for 3 additional years, and 15% in year 7. Capital gains taxes on stock profits are 0%.

The purpose of the conference was to introduce venture capital and private equity investors to Chinese entrepreneurs and potential business opportunities coming out of the Haidian universities and to educate the entrepreneurs about venture capital. We had an audience of 300 plus, including many U.S. investors, who came to hear about what the opening of China’s capital markets later this year will mean for investors.

JR

Posted by John Rutledge at 11:58 AM

All the Comforts of Home

(Beijing, 9/9/06) Thought you would like to see a picture of my favorite “office” in Beijing. As you can see, I have everything a man needs to work. FYI, this is a REAL Starbucks, not a knock-off like the one I showed you a few months ago in Harbin. And the espresso is magnificent.

I also took a short video of Peter and Rebecca (the two young baristas at the counter) welcoming you to Starbucks, but will have to post it after I return to Connecticut where there are people more technically adept than me at uploading video files.

JR

Posted by John Rutledge at 11:55 AM

September 1, 2006

Emerging Markets Review

(Greenwich, 9/24/2006) The Internet has bred a proliferation of new journals--especially on emerging market issues that were formerly poorly covered--that is providing researchers around the world with many more outlets for their papers. I am hoping to take advantage of that to help young faculty members at Hunan University reach a wider audience with their work.

The latest issue of the Emerging Markets Review, Volume 7, Issue 3, Pages 191-278 (September 2006) has several interesting articles about investing in emerging markets. You can have the table of contents for each issue of Emerging Markets Review (and many other journals) as well as abstracts of articles emailed to you at no charge (although there is a charge for full articles) by registering at Science Direct at www.sciencedirect.com.

1. Coming to America: IPOs from emerging market issuers, by Robert Bruner, Susan Chaplinsky and Latha Ramchand examines the issue costs of 299 companies from emerging and developed market countries making initial public offerings (IPOs) in the United States between 1991 and 2001. Surprisingly, they find that IPOs from emerging markets experience the same costs on average as IPOs from developed market countries.

The reasons? Emerging market issues tend to be more NYSE, less NASDAQ than U.S. IPOs. They tend to be old economy companies rather than tech companies. They are larger, higher-quality companies--frequently privatizations of state-owned companies with long histories. And they are clustered near the end of bull markets (when investors are temporarily insane and investment bankers are eager to write one more ticket before the door closes.) You can read an abstract of the article by clicking here.

This issue is omportant because we are going to see a lot of very large public offerings coming out of China through the Hong Kong and Singapore markets.

2. Earnings estimates in emerging markets—an update, by George R. Hoguet reviews the availability and timeliness of earnings estimates for public companies in emerging markets. He finds that there are nine earnings estimates per security in Fiscal Year 1(FY1) and 8.7 in FY 2, higher than both the MSCI Japan Index and the Russell 2000 Index. You can read an abstract by clicking here.

3. Changes in the dynamic behavior of emerging market volatility: Revisiting the effects of financial liberalization by Juncal Cuñado, Javier Gómez Biscarri and Fernando Pérez de Gracia shows that over the period 1976–2004 financial liberalization of emerging markets has generally reduced the level of market volatility and its sensitivity to news. You can read an abstract by clicking here.

This is an important issue because this year China is dramatically opening its capital markets as required in the WTO agreement.

JR

Posted by John Rutledge at 7:48 PM