Finance Digest for Week of February 7, 2005

GREENSPAN PAYS TRIBUTE TO FATHER OF MODERN ECONOMICS, 18TH-CENTURY PHILOSOPHER ADAM SMITH

Greenspan, who this month began his final year as Fed chairman, delivered the Adam Smith Memorial Lecture at Fife College in Kirkcaldy, Fife, Scotland, where the early proponent of free-market capitalism was born in 1723. “In his Wealth of Nations, Smith reached far beyond the insights of his predecessors to frame a global view of how market economies, just then emerging, worked,” Greenspan said in a text of his remarks. “In so doing, he supported changes in societal organization that were to measurably enhance world standards of living,” Greenspan said.

Smith, who died in 1790, argued that while free markets might appear chaotic, they actually were guided to produce the right amount and variety of goods by what he called the “invisible hand” of supply and demand. If a product were in short supply, its price would rise, prompting more producers to enter the market, Smith argued. “It was left to Adam Smith to identify the more general set of principles that brought conceptual clarity to the seeming chaos of market transactions,” Greenspan said. “Most of Smith’s free market paradigm remains applicable to this day.” In his 17 1/2 years as Fed chairman, Greenspan has promoted his own views that the economy works best with less government regulation.

WANTED: OBJECTIVE CREDIT RATINGS

For years, the nation’s credit rating agencies have thrived, booking mouth-watering profits from operations that are riddled with conflicts and shielded from competition. Soon, however, that may finally change. Within the next two months, the S.E.C. will press a new regulatory framework for the industry to ensure that debt ratings published by the big three -- Standard & Poor’s, Moody’s Investors Service and Fitch Ratings -- are a result of thorough analysis, not a desire for fatter profits.

Now that would be an upgrade, long overdue. Indeed, given how regulators have attacked conflicts of interest among Wall Street firms, insurance companies and other financial services concerns, it is astounding that the ratings agencies have been allowed to go on this way for so long. Rating agencies play an enormous role in a huge market. After all, far more debt is issued than stock. Last year, corporations issued $1.2 trillion in straight debt versus $146 billion raised in common stock. An additional $1.4 trillion was issued last year in mortgage debt and asset-backed securities. All that paper needed a rating before it could be sold to the public. As such, the financial markets rely heavily on the companies that rate them.

Since 1931, for example, the Federal Reserve Board, the Comptroller of the Currency and federal and state laws have regulated the debt held by banks and other financial institutions, using credit ratings assigned to the debt. Pension funds, banks and money market funds are barred from buying debt issues that carry ratings below a certain level. But not just any rating agency’s rating, mind you. In 1975, the S.E.C. ruled that the laws relating to debt carried by banks and financial institutions refer only to ratings provided by agencies that it recognizes. Right now, these are the big three and a much smaller fourth, Dominion Bond Rating Service of Canada. What you have, in other words, is an oligopoly.

This oligopoly earns its keep from fees charged to the companies whose debt it rates. This conflicted business model means that the paying customers for these agencies are the corporations they analyze, not the investors who look to the ratings for help in assessing a company’s creditworthiness. Rating agencies typically receive the largest fees when they analyze an initial bond issue. After that a nominal fee is levied, providing something of a disincentive to do in-depth, time-consuming work.

Because the nation’s courts have ruled that the work of these agencies is opinion and therefore protected by the First Amendment, the big three are protected from lawsuits from investors contending defective analysis. Such lawsuits could act as policing mechanisms. Meanwhile, these companies have recently begun to expand the services they offer to corporations, leading regulators to fear that ratings could be swayed by revenues earned on other products. These problems are on the agenda for when Senator Richard C. Shelby, the Alabama Republican who is chairman of the Banking, Housing and Urban Affairs Committee, holds hearings on the state of the rating agencies.

Increased competition would certainly help investors who are troubled by the conflicts. But companies hoping to break into the ratings game must first earn the all-important designation from the S.E.C. One upstart concern that has applied unsuccessfully to the S.E.C. is Egan-Jones Ratings, of Philadelphia. It rates approximately 800 companies and had warned of problems at WorldCom, Enron and Global Crossing well before other agencies. Egan-Jones does not accept payment from companies it rates; investors who use its services pay the freight. A recent academic study found that Egan-Jones’s ratings changes were more timely than those of Moody’s, coming up to six months sooner. The study also found much higher stock returns after rating changes by Egan-Jones than by those of Moody’s.

Debt-rating firms resist prospect of more supervision.

The big three credit-rating companies said in a congressional hearing that they welcome more competition, but stopped short of agreeing to more federal oversight, as members of the Senate Banking Committee raised concerns about conflicts of interest and other questions about the industry. Raymond W. McDaniel Jr., president of Moody’s Investors Service, said he would not oppose giving up his firm’s national designation, which the SEC granted in 1975. The presidents of Standard & Poor’s and Fitch Ratings said they would support an SEC process that allows competitors to obtain the national designation. But Kathleen A. Corbet, S&P’s president, said it is “imperative” that regulators “avoid overly intrusive supervision”.

JOE GRANVILLE IS STILL ACTIVE, AND SEES DOOM FOR DOW

The 81-year-old prognosticator and author of his own Granville Market Letter can barely disguise his disdain at the happy bulls who are shrugging off January’s mini-slump and insisting the markets are swimming along just fine. “We’re sitting on the most dangerous highs in years,” Granville said, pointing to the latest cycle that has pushed the Dow up 40% since March 2003. By his reckoning, the current lofty levels mean the timing is right for a big fall. He sees the blue-chip index dropping to 7,400 before the end of the year, just below its March 2003 level. The Nasdaq will fare even worse, dropping over 50% to under 1,000, he predicted.

Granville’s game is timing the market by looking at historical price trends -- and nothing more. He cares nothing about the latest news from Iraq, the ups and downs of the economy, or the sunny forecasts of many corporate CEOs. And do not even get him started on profits. “Earnings are not a predictor of stocks,” Granville said emphatically. “If anything, my charts have always shown that you buy stocks when earnings are down, and sell when they’re moving up. People do the obvious. They turn on the TV and get the latest news and earnings, but I turn my audio down,” he said. “I constantly watch what the market is doing, not what the news is doing.”

To be sure, Granville’s market-timing techniques have brought mixed results over the years. He correctly predicted the bear market of 1973-74, and was among the first to warn tech stocks were overheated in 2000, when the Nasdaq passed 5,000. But he completely missed the big bull run of 1982 to 1986, a stretch that saw the Dow more than double. Still, he is proud of the system he has stuck with for nearly a half century. It skips what he sees as trendy stock picking habits based on good stories -- think of all the dot.coms of the late 1990s -- and an obsession with quarterly profits.

Just like old times as Joe Granville yells “Sell”.

It brought on a rush of nostalgia to read the other day that Joe Granville is predicting trouble for the stock market in 2005. Talk about a blast from the past. Granville is a market- letter writer in Kansas City, Missouri, who has been operating for close to half a century in a business not known for fostering long careers. His influence and renown reached a peak in the early 1980s. Nobody who owned stocks in those days will forget the time in early January 1981 when Granville sent out a “Sell Everything!” message to his subscribers that made headlines around the world. The Dow Jones Industrial Average fell 2.4% the next day and an additional 1.5% the day after that.

Now here he comes again, flamboyant as ever at the age of 81, telling Bloomberg’s Ari Levy in a Feb. 4 news story, “We’re in the critical portion of a coming collapse and the market's screaming to get out.” Who says there is no continuity left in modern life? Amid all the upheaval in technology, tastes and temperaments, some things have not changed a bit. One difference now is that Granville does not spook a market the way he once did. Few people ever have, before or since.

THE BEST TIMES TO SELL YOUR HOME

Wondering whether to sell your home -- and when? Put away the tea leaves and star charts. And while you are at it, pack up the conventional wisdom. The good news for sellers is the nation as a whole has seen a sizzling real estate market over the last several years. From the third quarter of 1999 to the third quarter of 2004, American home prices increased more than 48%. The bad news is that things are a little more complicated than “buy low, sell high”. And while tradition has it that spring is the best time of year to market a piece of property, that is not true in every locale. Throw in the fact that the old cycles have been thrown off by a tight housing market, and it is enough to make a homeowner’s head spin.

“It’s a good time to sell your home,” says Theodore Kaplan, who specializes in real estate at the Manhattan law firm Kaplan Fox & Kilsheimer, “if you have another place to go.” It is tempting to cash out of a home and realize the gains of the past several years. But it's a risky proposition unless you are downsizing your residence or moving from a very expensive market, such as New York City, to a less pricey one, such as Atlanta. Otherwise, you will end up spending just as much -- if not more -- on new digs. “The market is moving much faster than data can be collected,” says Jacky Teplitzky, an executive vice president at New York-based Douglas Elliman. “For prices, you can’t even look at what [has] sold -- you have to look at what’s in contract right now.”

A NEW INQUIRY INTO NYSE SPECIALISTS

The U.S. attorney’s office in Manhattan is investigating individual traders on the floor of the New York Stock Exchange on suspicion of cheating customers through illegal trading practices already under scrutiny by the S.E.C. and the exchange itself, according to someone who has been briefed on the investigation. The criminal inquiry is an escalation of the investigation, begun by the Big Board in the summer of 2002, into the activities of stock exchange specialists -- traders who manage the buying and selling of particular stocks and have an obligation to stabilize markets in the stocks they manage -- from 1999 to 2003. There are two trading practices at issue in the investigations: executing proprietary orders before customer orders, and getting involved in a trade that should be carried out automatically with no intervention.

The specialist investigations also add fuel to the argument, made often by critics of the Big Board, that computers are more effective at trading stocks than humans. The exchange, which has long contended that its system allows investors to get better prices with fewer big price swings, has been engaged in an intense effort to develop new technology and rules to allow more trading to be automated.

DOLLAR HITS 3-MONTH HIGH VS. EURO AFTER G7

The dollar hit a 3-month high against the euro and closed in on a 1-month peak versus the yen on Monday after China told the world’s richest nations that it was committed to revaluing its currency but would not do so soon. Surprisingly optimistic comments from Federal Reserve Chairman Alan Greenspan about the massive U.S. current account and trade deficits were also taken as a signal to buy the dollar. China, invited to the Group of Seven talks in London at the weekend, came under renewed pressure to ease the yuan peg to the dollar but said it had no timetable for action on G7 complaints that it keeps the yuan too low, making life hard for other trading nations. The dollar was also supported after the G7’s statement on currencies repeated a desire for more flexibility and less volatility in the foreign exchange market.

Greenspan not really optimistic on account gap.

Federal Reserve Chairman Alan Greenspan, speaking in London last week, put the best face he could on the outlook for the burgeoning U.S. current account deficit. Currency markets, perhaps misled by the seemingly hopeful tone of Greenspan’s remarks, responded by bidding up the value of the dollar. They should have listened more closely to all his carefully worded caveats and conditional phrases.

RETIREMENT TURNS INTO A REST STOP AS BENEFITS DWINDLE

Employers had better get used to seeing older people’s résumés. As numerous companies across the country withdraw retiree medical and dental benefits while others switch to less generous retirement plans, many aging workers who had expected to ease comfortably out of the labor force in their 50’s and early 6’qs are discovering that they do not have the financial resources to support themselves in retirement. As a result, a lot more of them are returning to work.

Since the mid-1990’s, older people have become the fastest-growing portion of the work force. The Labor Department projects that workers over 55 will make up 19.1% of the labor force by 2012, up from 14.3% in 2002. Until recently, most economists said that older people were being lured back into the labor force largely because of opportunities growing out of the vibrant economy of the 1990’s. But these days, they say, many such Americans are being drawn to work out of necessity rather than choice. As the nation gears up for a fundamental debate over the future of Social Security, these circumstances hint at potential changes in the federal program that supports more than 40 million elderly Americans.

Just as companies are seeking ways to reduce their roles in financing former employees in retirement, many economists say that the Social Security program should also scale back in response to the aging of the population. Some have pointed out that continuing to raise the official retirement age in step with increases in Americans’ average longevity could probably guarantee Social Security’s solvency forever.

To some extent, that transition is already under way. As they stay longer in their jobs or peruse the help-wanted ads for post-retirement employment, Americans are reversing what had been a nearly century-long decline in the participation of older people in the work force. Made to carry more of the burden of their retirement, many retirees say they feel that a social compact between workers and employers -- a set of expectations established over the second half of the 20th century -- is being dismantled.

Consumers hit harder by medicine copayments.

A majority of consumers said the biggest change in their health insurance last year was higher copayments for prescription drugs, according to survey results. The results are another indication that patients are bearing an increasing burden of healthcare costs. The informal survey of 915 visitors to the website of Weiss Ratings, a financial risk analysis firm, found that 34.3% said the higher drug copayments they must pay reflect the biggest change, while 23.8% said the copayment for a visit to the doctor was biggest.

“Absent any real reform in truly managing care, it’s going to cost more -- and that is being passed along to individuals,” said Melissa Gannon, a vice president at Weiss Ratings, which specializes in health and other forms of insurance. The findings echoed a major, more scientifically rigorous survey of employers last year by the Kaiser Family Foundation, a nonprofit research organization in Washington, that showed sharp increases in prescription copays over the past five years. That poll broke down patients’ share of costs within so-called tiered copayment arrangements, which have become ubiquitous in prescription drug coverage.

In tier 1, which includes the cheapest generic drugs, average copayments rose to $10 in 2004 from $7 in 2000. In tier 2, for brand-name drugs the insurer has designated as the “preferred” choice, average copayments rose to $21 from $13 in 2000. And for the brand-name drugs designated by the insurance company as “nonpreferred” and placed in tier 3, the average copayment nearly doubled, to $33 from $17. The result is rising sticker shock for people on maintenance medications, particularly the elderly

HEALTH COSTS BURDEN GM BY $4 BILLION, CEO SAYS

General Motors spends $4 billion a year more than its largest global competitor, Toyota, for employee and retiree health care, GM Chairman Rick Wagoner said. In other words, no matter how well GM runs its business, it can hardly hope to compete effectively for the long haul with such a huge, health-care cost gap. The fact that Toyota is renowned as the planet’s most efficient car manufacturer does not make the task any easier.

Toyota made about $10 billion in profits in its fiscal year ending in March 2004; GM made $3.8 billion in calendar 2004. GM sold nearly 9 million cars and trucks worldwide last year; Toyota expects to sell 7.3 million in its fiscal year ending next month. Wagoner, in a speech to the Chicago Economic Club, cited health-care costs, currency manipulation by Japan, and lawsuit abuse as three critical challenges to the competitiveness of GM and other U.S. manufacturers.

PWC VIOLATED INDEPENDENCE RULES

The conflict, involving cash-handling services related to tax withholding, was disclosed by the Big Four firm and by one of its audit clients; “it’s likely that there will be more companies disclosing this,” says a PwC spokesman. PricewaterhouseCoopers LLP has acknowledged violating auditor-independence rules, according to The Wall Street Journal. PwC spokesman David Nestor told the newspaper that the auditing firm discovered the issues as part of a broad-based internal review of its independence policies. Nestor added that the firm reported the violations to the SEC and the Public Company Accounting Oversight Board.

In an SEC filing last week, added the Journal, the conflict was confirmed by PwC client Parker Hannifin. The maker of motion and control technologies and systems reported that it was recently advised by the Big Four firm that certain expatriate cash-handling services related to tax withholding -- performed for a Parker Hannifin subsidiary by a PwC affiliate in China -- “have raised questions regarding PwC’s independence with respect to its performance of audit services.”

SEC CAME DOWN ON SIDE OF SHAREHOLDER INEQUALITY

Iraqis now can choose their leaders. Halliburton investors still cannot. The SEC again championed shareholder inequality, squelching hopes that this proxy season might give investors a voice in how their investments are governed. Halliburton, Verizon Communications and Qwest Communications International want to block shareholders from using proxy materials to nominate directors. The SEC assured them that companies excluding such proposals from this year’s proxies will not face enforcement action. The decision comes on the heels of a similar one by the SEC in late December that allowed Walt Disney to brush aside shareholder nominations. A proposed rule allowing investor nominations has been stalled before the SEC for more than a year.

Several pension funds hoped to accelerate the process using a provision that said shareholders could submit nomination proposals while the SEC debated the rules. But SEC Chairman William Donaldson, who in the last few months has swapped his reformist attitude for the demeanor of a corporate shill, last year withdrew his earlier support for the proposed rule and has refused to say when the commission will take up the issue or offer an alternative. The rule-making process is mired in politics as companies and business groups pressure the SEC to ease recent reforms aimed at making public companies more accountable.

Halliburton, Verizon and Qwest have sought refuge in the SEC’s decision. The commission’s foot-dragging has provided a convenient shield from corporate responsibility. Companies of conscience do not need the SEC to tell them they should listen to investors. Doing the right thing does not require permission, and it should not require a mandate from a government agency.

BANK OF ENGLAND’S KING WANTS BOREDOM; SO DOES CHINA’S ZHOU?

BoE Governor Mervyn King, a self-professed practitioner of “boring” monetary policy, now wants the world’s key central banks to make a combined attempt at global dullness for the sake of stable currencies. “The aim of central banks to make monetary policy less exciting and more boring needs to be complemented by a collective effort to bring boredom to the international monetary stage,” King said in a speech preceding a meeting of policy makers from the Group of Seven industrialized nations in London last week. By agreeing that the “recent melodrama” of volatile currencies is a risk to global monetary stability, Europe, Asia and the U.S. may be able to find a “cooperative outcome that’s an improvement for all, not just for some.” King said.

Stable currencies will provide a setting for world trade to prosper, though achieving it would require the support of the Chinese, whose currenc’qs decade-old peg at 8.3 to the dollar is seen by many analysts as the main hurdle to an orderly adjustment of global current-account imbalances and the key reason why flexible European currencies have had to bear almost the entire burden of the dollar’s decline in the past three years. The King plan rests on the viability of “a common analysis” of the problem by the key players, including China. That, at the moment, looks like an elusive goal because People’s Bank of China Governor Zhou Xiaochuan, while himself aspiring for a certain tediousness in the global exchange rate regime, appears to have a very different opinion about what level of monotony will be ideal for his country.

HOW WALL STREET LEARNS TO LOOK THE OTHER WAY

The NYSE’s report on the pay package given to its former chairman, Dick Grasso, made clear the excessiveness of the compensation and the ineffectiveness of the safety controls that failed to stop it. What the report did not provide, however, was an answer to an obvious question: Why did nobody on the exchange’s board look at that astronomical sum and feel some personal responsibility to find out what was happening?

I think it is fair to say that to some extent the players in this drama -- as well as those in the ones now being played out in courtrooms and starring former executives of Tyco, WorldCom and HealthSouth -- have been shaped by the broader business culture they have worked in for so long. And, as with any situation in which we are puzzled by how a group of people can think in a seemingly odd way, it helps to look back to how they were educated. Education molds not just individuals but also common assumptions and conventional wisdom. And when it comes to the business world, our universities -- and especially their graduate business schools -- are powerful shapers of the culture. That said, the view of the world that one gets in a modern business curriculum can lead to an ethical disconnect. The courses often encourage a view of human nature that does not inspire high-mindedness.

Consider financial theory, the cornerstone of modern business education. The mathematical theory that has developed over the decades has proved extremely valuable in general. But when it comes to individuals, the theory runs into some problems. In effect, it portrays people as nothing more than “maximizers” of their own “expected utility”. This means that people are expected to be totally selfish, constantly calculating their own advantage, with no thought of others. If the premise is that everyone would steal the silverware if he knew he could get away with it, and if we spend the entire semester developing the implications of this assumption, then it is hard to know where to begin to talk about ethics.

Modern business education often encourages excessive respect for anything that can be considered a result of the free market. For example, a leading corporate finance textbook lists the efficient markets theory (“security prices accurately reflect available information and respond rapidly to new information as soon as it becomes available”) as one of the seven most important ideas in finance. The other six are even less personal, models of perfect markets that only mathematicians can fully appreciate. It should not be surprising that those who were trained by books like these would not consider the possibility that there could be a bubble in executive compensation.

Many schools now offer a course in business ethics, and some even try to integrate business ethics into their other courses. But nowhere is ethics seen as a centerpiece or even integral part of the curriculum. And even when business students do take an ethics course, the theoretical framework of the core courses tends to be so devoid of moral content that the discussions of ethics must seem like a side order of some overcooked vegetable. I like to assign my finance students Take On the Street, an account by Arthur Levitt of his efforts, as chairman of the S.E.C. in the 1990’s, to clean up the sleazy side of Wall Street. I wish more professors assigned it. But most of my colleagues tell me they do not have time for it; too many formulas to cover.

Ultimately, the problem at the university level is a tendency toward overspecialization. The specialty of financial theory has largely come to be defined by skills manipulating a narrow class of mathematical models of purely selfish behavior. Business ethics is just another academic specialty, and can seem as remote as microbiology to those studying financial theory. Whatever happens with Mr. Grasso -- and with Dennis Kozlowski of Tyco and the other avatars of corporate misconduct in the headlines these days -- we should be reminded that ethical behavior for many business people must involve overcoming their learned biases. Perhaps these scandals would be a little less likely, and the rationalizations for them a little less tenable, if more of us professors integrated business education into a broader historical and psychological context. Would our students really fail to understand the economic models if we treated the subject matter not as an arcane specialty, but as part of a larger liberal arts education?

FITCH WARNS OF U.S. RATES JUMP THREAT TO EMERGING MARKETS DEBT

A sharp fall in the U.S. dollar is the biggest threat to emerging market debt prices, says Fitch, the credit ratings agency. In a report published this week, Fitch said a sudden decline in the dollar could spark an unexpectedly sharp rise in U.S. interest rates, which would prompt investors to demand higher returns on risky debt. This, the agency said, could fuel turbulence in emerging market bond prices, which last year rallied strongly. Emerging markets have not had to contend with a sharp rise in U.S. rates since 1994, when yield spreads over U.S. Treasury bonds widened dramatically.

“We do not believe that an environment as favorable as that in 2004 will last,” analysts at Fitch said. “A high-risk appetite may be causing investors to underplay emerging market risk, particularly among weaker credits.” Fitch said U.S. interest rates were in any case likely to rise faster than current futures prices suggested, estimating the cost of borrowing at 4% by the end of this year, up 1.5 percentage points from the current level of 2.5%.

THE DEBATE IS NOT WHETHER THE BUDGET WILL BE SMALLER, ONLY HOW MUCH LARGER IT WILL BE

The FY 2006 budget proposal got a lot of ink today, as well it should: the small print offers countless examples of the absurd and outrageous. Yes, I realize that this budget had “the first outright cut in this wide swath of government programs proposed by any president since Ronald Reagan,” and I also know that critics called it “mean, not lean”.

These debates are misleading at best. The quibble is not about making government smaller, only about how much larger it will be. The budget has increased in every one of the past 30 years. Look it up. The Federal government will collect more taxes in the new fiscal year than in the previous one (again); it will spend more than it collects (again); and, its total spending will exceed total spending in the previous year (did I say “again”?).

Early this morning I came across an AP wire story about the Department of Transportation budget: the article said the department was getting a spending increase for a new headquarters building, to the tune of $100 million. $100 million for a new building? I tried to find where the enterprising reporter saw this, but I was unable to. It was nowhere in the 12-page OMB summary of the Department of Transportation’s budget. Nor was it in the 27-page summary tables of the entire budget, but there sure was a lot of other stuff. For example, you may think that $29.3 billion should equip the Department of Homeland Security to carry out its mission. Apparently not, because tens or hundreds of millions of additional Homeland Security dollars were also doled out to every other cabinet-level agency and then some -- including the Smithsonian Institution ($75 million), the National Science Foundation ($342 million), and the Department of Health and Human Services ($4.2 billion). There was also my favorite line item in any respectable funding table, the ever-present “Other”, in this case “Other Agencies”, which received $813 million.

THE MOGAMBO GURU TAKES ON NOBEL PRIZE WINNING ECONOMIST JOSEPH STIGLITZ

“No one -- not the president, the secretary of the treasury, or the chairman of the Federal Reserve -- can be blamed for this irrational exuberance; but they can be blamed for not dealing with the consequences, and in some cases, for feeding the frenzy. After a faint effort to let the air out of the bubble, the Fed simply added to the hype.” ~~ Joseph Stiglitz in The Roaring Nineties: Seeds of Destruction.

Joseph Stiglitz, in an excerpt from his new tome carried in The Guardian, examines the bubbles fostered in the U.S. during the 90’s from his lofty viewpoint as part of “we in the Clinton administration”. His blatherings are part educational, part anti-educational, part nonsensical, part historical, and mostly self-exculpatory.

Earth to Mr. Stiglitz! Yes, the President, the Secretary of the Treasury, and especially the Fed Chairman CAN be blamed for the bubble mania, and I, the Mighty Mogambo, point my long and bony finger at them and say “Shame! Shame!” Their every action was in reckless pursuit of expanding and exploiting the bubble economy via growing government meddling. And also highly blameworthy, of course, is Joseph Stiglitz himself, who, armed with his precious Nobel Prize in economics, supposedly knew better and should have said something and done something, but chose to go along to get along. And now, I note with disdain, that he is defending his lack of responsibility.

People like Mr. Stigliz make sure that the government is never ever satisfied with where it is, it must be always growing bigger, always spending faster, always reaching farther, always grabbing for more, more MORE power until we are landed in one of those Big Brother scenarios that I am sure you do not want the Mighty Mogambo to go off on just now. Anyway, you can be very sure the government IS to blame.

WARREN BUFFETT AND BILL GATES DO NOT A MANIA MAKE

Now that the reality of the falling dollar has finally registered with the average American, and has been covered broadly by the media and has even been the subject of parody on Saturday Night Live, some individuals are raising the concept of a “inverse dollar bubble” in hopes of persuading investors to return to U.S assets. However, any attempt to equate the irrational stock market mania of the late 90’s, with a supposedly “irrational” fall in the dollar over the last three years, should be seen as empty rhetoric that merely reflects fantasy and ignorance, not reality and insight. The fact that Warren Buffett and Bill Gates, two of the world’s wealthiest individuals, have signaled their agreement with former Fed Chairman Paul Volker’s warnings of a dollar collapse by protecting their wealth through diversifying out of dollars, does not constitute a bubble in non-dollar assets.

While it is true that the dollar’s decline has been a mainstay in the financial headlines recently, to expect otherwise, given the importance that such movements have on the global economy, would be absurd. However, most of that coverage has been focused on the supposed benefits to American exporters and corporate profits, with relatively little attention given to it being symptomatic of a fundamental problem with the American economy, or portending any looming economic crisis. Proponents of the “inverse dollar bubble” assert that the media are so hungry for anti-dollar sentiment that they will rush to quote anyone spouting doom. As one who has been in contact with hundreds of reporters over the past several years, I can assure anyone harboring such delusions, that this is certainly not the case. While I have been quoted a bit more often recently, such attention has only come after years of accurate forecasts. In reality, the vast majority of mainstream reporters still consider my bearish dollar outlook too radical for quotation.

Having just returned from the Orlando Money Show, I can assure anyone that the position that dollar bearishness has risen to the height of fashion is completely contradicted by reality. While my two presentations on the bearish case for the dollar were well attended they were greatly over-shadowed by those espousing the opposite point of view. Much more numerous in numbers, the dollar bulls were assigned the biggest rooms and spoke to significantly larger audiences. One attendee commented that my bearish outlook contradicted every other presentation he heard. Further, as hundreds of investors passed by my booth each day, those who had taken any action at all with respect to non-dollar investments were few and far between.

The fact is that despite all the talk of dollar weakness, there has been very little action on the part of dollar holders to do anything about it. I cannot speak for anyone else, but I have yet to go to a cocktail party where non-dollar strategies were being discussed. I have yet to over hear any such conversations at restaurants or while waiting in lines. I have yet to hear one cab driver comment on the profits he made in European bonds, or a single men’s room attendant give me a tip on a hot resource play in New Zealand. In order for a mania to exist in an asset class, it is necessary for there to be wide-spread ownership in the asset, and a general belief among those buying it that its price can only go higher. For there to be a mania in non-dollars, the average American would have had to have already sold his dollars. How many people do you know who have bank accounts in foreign currencies?

Warren Buffett is one of the few prominent investors to have correctly identified the NASDAQ mania of the 1990’s as a bubble while still in formation, and to have had the discipline not to participate. Does it make sense that someone with enough investment savvy to have avoided that bubble, to now be foolish enough to participate in an alleged bubble in non–dollar assets? In fact, the same wisdom that guided Buffett to avoid tech stocks then, is the same wisdom that has him avoiding dollars now. In addition, during the tech bubble of the 1990’s the NASDAQ increased 20-fold, to an absurd level never before reached in history. By contrast, the U.S. dollar Index is still higher than it was 15 years ago. In fact, all the dollar has done over the past three years is surrender the unwarranted gains it achieved during the tech bubble, when the world sought dollars to participle in the quick profits promised by the “new economy”.

The problems for the U.S. economy and the dollar have been a long time in the making, and the fact that a few of us were able to correctly diagnose the disease before its symptoms become more apparent to a small group of astute, high profile investors, should not be used to discredit our conclusions, especially as it appears the chickens are finally coming home for a long over do roost.

THE BIG LOSER

A year ago, I explained that 2003 had been an unusual year in the sense that all asset classes -- including bonds, equities, commodities, real estate, and art -- had risen in value, and that 2004 would see the emergence of some diverging trends among these various classes. Well, I was wrong! In 2004, all asset classes continued to increase in value -- with the exception of the U.S. dollar, which depreciated further against stronger major currencies such as the Euro, the Swiss Franc, and the Yen. The U.S. dollar lost even more in value against some of the more exotic currencies, such as the Polish Zloty (+23.9%), the South African Rand (+18.1%), and the Colombian Peso (+18.1%). In 2004, U.S. dollar holders may, however, have found solace in the fact that against the Zimbabwean dollar, the Greenback appreciated by 85%, and is up by 99% since 2000.

It is important to realize that the strong appreciation of the Euro and other European currencies over the last two and a half years has led to a very significant overvaluation of the Euro against the Asian currencies, which, since the beginning of 2000, with the exception of the Korean Won (up since then by 8%), have hardly moved against the U.S. dollar. So, whereas since January 2000 the Swiss Franc, the Euro, and the Pound Sterling have risen by 35%, 29%, and 14%, respectively, against the U.S. dollar, over the same period the Japanese Yen is up by just 3% and the Singapore dollar by 2.5%, and the Taiwan dollar is down by 3%.

I mentioned above that in both 2003 and 2004 all asset classes rose in value. Therefore, when I look around the world I find very few bargains among bonds, equities, properties, and industrial commodities. Yet, largely due to currency movements, relative values seem to exist in Asia where asset values (equities and real estate) appear to be inexpensive compared to the rest of the world. So, stock market bulls are once again advised to increase their weightings in Asia, including Japan, where it is common in most countries for dividend yields on individual stocks to exceed domestic bond yields.

However, since all asset prices have risen strongly over the last two years, two possibilities should be considered. In the long term it is, of course, inconceivable that commodities, real estate, and bond prices will all rally at the same time. Rising commodity and real estate prices do lead, at some point, to inflation in consumer prices and so to more obvious inflation. Rising interest rates follow, which then depress bond prices. Therefore, what I expected to occur in 2004 -- namely, the emergence of some diverging trends -- is likely to shape the financial landscape in 2005. If U.S. monetary policies were to remain loose, a further weakening of the U.S. dollar, rising CPI inflation, and rising long-term interest rates would almost certainly follow.

The question in this expansionary monetary policy scenario is to what extent asset prices could continue to appreciate if inflation and a weak dollar were to drive 10-year U.S. Treasuries’ interest rates to between 5% and 6%? In a society addicted to debt, and where asset prices have been badly inflated, even a small increase in interest rates could have serious implications for all asset prices!

AN INTERVIEW WITH JIM ROGERS

If you are a fan of “Wayne’s World” from Saturday Night Live, you will certainly remember Wayne and Garth bowing down before Rock God Alice Cooper repeating, “We’re not worthy! We’re not worthy!” That is how I felt in the presence of Adventure God, twice-‘round-the-world author, Jim Rogers. His first trip in 1990 was on a motorcycle. It yielded the book Investment Biker. In his more recent Millennium Tour, he traveled for three years to 116 countries in his custom-built, sunburst yellow, hybrid Mercedes. This trip was the genesis of his book, Adventure Capitalist. The financial reference in both titles is no coincidence. Rogers entered the investment business in 1968 with $600 in his pocket. Thanks to some brilliant investment strategies he was able to retire 12 years later. But this was just the beginning of an even bigger adventure. As he says in Adventure Capitalist, “What I wanted out of Wall Street, and ultimately out of long-term investing, was not typical of the business. I wanted to buy the freedom to taste as much of life as possible -- I wanted to see the world.”

Although everyone’s goal may not be to retire young and travel around the world, Rogers is still an inspiration to all of us! He figured out what he was passionate about and went for it -- risk, thrills, and all. In our interview, Rogers talks about the future of America, exciting investment opportunities, his new book, Hot Commodities, and his biggest adventure yet -- his precious baby girl (who does not own any dollars, just Swiss francs, and who will be learning mandarin Chinese).

Citigroup now supports commodities super cycle thesis.

Having hedged their bets for the past year, the commodities team at Smith Barney Citigroup has now reached a definitive conclusion -- commodities are in an extended cycle that in turn is part of a “Super Cycle”. This marks a change from their stance over the past year where they considered the “Super Cycle” to be a genuine possibility but felt there was insufficient evidence to confirm the thesis. While noting the commodity cycle is reaching maturity and is therefore producing some sell signals, Citigroup is confident of a sustained period of earnings growth and a quality of earnings not seen before in the sector and which will be enough to outweigh the conventional sell signals.

So what does a ‘Super Cycle’ mean? Importantly, it does not mean commodity prices will simply rise in a straight line, as there will still be price cycles. Rather, the ‘Super Cycle’ produces a sustained period of trend increases in real commodity prices, which is driven by higher trend growth as major economies industrialize and urbanize. As the cycle continues, Citigroup explains real commodity prices will continue to trend higher, to the point where the trend decline experienced over the last 30 years will reverse.

While prices generally are expected to rise, some commodities are expected to outperform within the cycle. In Citigroup’s view, the preferred commodity exposures in this cycle are the bulks -- iron ore, coking coal and alumina, along with aluminium, zinc and gold. In addition, the broker expects shareholders to notice an important difference between a “Super Cycle” and an ordinary cyclical increase in commodity prices.

FUZZY MATH OBSCURES MORTGAGE RATE TRUTHS

Q: I have an irritating Primerica salesperson who wants me to switch my mortgage to him. I am at 5 7/8%, and his mortgage rate is around 8%. But he claims Primerica’s mortgage is simple interest and will save me money. Plus he claims his company is the only one that offers a simple mortgage interest rate. I am tempted to do this because I have about $21,000 in credit card debt that I would like to put into a mortgage and be done with. What do you suggest? And what can you tell me about his claims?

A: If you Google “Primerica (plus) simple interest”, you will find that you are not alone. Many are confused by sales claims made by Primerica’s agents, who are often impressionable true believers who do not really understand how direct-reduction mortgages work.

The best way to make the greatest reduction in the cost of financing your home is to think of it as a two-step process. The first step is to find the lowest possible interest rate for a given term of loan. The second step is to accelerate the pay-down of that loan by making additional payments. Now let us think about what this guy is proposing. He wants you to give up your 5 7/8% mortgage and replace it with an 8% mortgage so you can save interest? In fact, your effective interest rate on the additional money borrowed -- that $21,000 in credit card debt -- would be painfully high. What this salesperson is offering does not make sense on any level. You do not want him anywhere near your finances.

A CALL TO INACTION

In a recent edition of this site’s Rude Awakening column, Eric Fry, your street-savvy New York editor commented that we might be “too contrarian for our own good”. We had come to the sudden realization that bonds could keep rising. Soon after, we stated our opinion in the Rude Awakening. This prompted Eric’s remark. We also closed out a short position in 30-year T-bonds that day ... for a large loss. So far, closing the trade seems like a sound decision. We pulled the plug on January 21, 2005, with 30-year Treasury yields at 4.68%. Yesterday, they closed at 4.37%. As the reason for our sudden change in heart, we cited an interactive poll, conducted at Morgan Stanley’s 2005 European Equity conference. 86% of the analysts present thought bond yields would rise in 2005, so we immediately took the other side of the trade.

Yesterday we found this roadside bomb in the Wall Street Journal: “All 45 economists polled by Blue Chip Financial Forecasts expect yields to be higher a year from now. The average forecast is 5.2%, almost identical to the -- inaccurate -- forecast the economists made a year ago.” Unanimity! We almost want to buy U.S. government bonds! Supreme trader, Dennis Gartman, also spotted the survey. “After this ‘fact’ we can be certain of one thing,” says he. “Interest rates at the long end of the curve are heading lower, not higher ... and perhaps much, much lower at that. Why? Because 45 economists say unanimously otherwise; that’s why!”

Of course, we would never actually buy bonds. When you buy bonds, you lend money to the U.S. government. If you bought them today, you would effectively receive 4.37% interest per annum, fixed for the next 30 years. As last week’s issue of The Economist puts it: “Short-term interest rates and inflation are both rising, the current account deficit is huge and widening, the dollar has fallen and the fiscal outlook has worsened. Surely investors looking over the next ten years will want a better return that 4.2%?” Actually, 10-year rates have moved lower since the article was published, closing yesterday’s session at 3.97%.

A market misvaluation is not the only explanation we can find for this puzzling bond behavior. The Economist puts forward three other possibilities. That investors have it wrong makes the most sense to us. But whatever it is that makes bond prices rise, we are reluctant to bet on it, just for the sake of trying to capture a short-term, counter-trend move. But nor do we want to share a trade with 45 unanimous economists. The best action, in this case, is probably inaction.

ARE CENTRAL BANKS REALLY DIVERSIFYING OUT OF THE DOLLAR?

As the U.S. dollar has extended its 3-year decline, there has been a host of rumours of central banks raising their exposure to EURs at the expense of USD holdings. This strong consensus of central bank diversification does not appear to be supported by existing data. In our view, once the BIS and IMF finally release their annual reports, the market will likely be surprised by the relatively small diversification into EUR assets in 2004.

In thinking about the question of reserve diversification, investors need to draw a distinction between the behaviour of Japan and China and that of the other central banks in the world. While we suspect that there has indeed been a move toward EUR-denominated assets away from USD assets by many central banks, we seriously doubt that Japan or China has been diversifying their reserves. China’s exposure to the USD is likely already prudent, from a long-term perspective, while Japan still holds the bulk of its reserves in USDs. Diversification by official institutions is a long-term objective: it will not occur when the USD is under pressure or so undervalued.

There has been much talk about the USD losing its hegemony to the EUR. We find this unconvincing. EUR has rallied by default, not by merit. Without outstanding merits, it is not possible for the EUR to supplant the USD as the dominant world currency. For this reason, reserve diversification will be limited in magnitude.

Russian central bank switches to euro-dollar basket in targeting ruble.

Russia’s central bank said it had begun targeting the ruble’s nominal exchange rate against the euro as well as the dollar. The shift is meant to bring currency policy more in line with trade flows. The Bank of Russia said in a statement it had begun targeting a dual currency basket -- made up of 90 U.S. cents and 10 euro cents -- as of Feb. 1 and would gradually raise the weighting of euros. “Increases of the weighting of the euro in the twin currency basket, to a level appropriate for the task of exchange rate policy, will take place step-by-step as market players adapt,” the statement said.

The announcement completes an informal shift undertaken by the central bank last year, when it was forced by market appreciation pressures to abandon a de facto nominal peg of the ruble to the dollar and allow it to rise. The greenback’s weakness on global currency markets, as well as Russia’s oil-driven current account surplus, have led central bankers to say they were looking more at the euro as a guide to day-to-day exchange rate targeting.

CHINA’S CHOICE

Chinese currency policy has now become a cause célèbre in world financial markets. To peg or not to peg -- and against what and when -- are choices only China can and should make. But given China’s increasingly important role in the world economy, there are important global consequences of these choices. The outcome could well bear importantly on world financial markets, the politics of trade liberalization, and ultimately the rebalancing of a lopsided world. To paraphrase a famous quip about the dollar uttered by former U.S. Treasury Secretary John Connally in the early 1970s, “The renminbi may be China’s currency, but it is our problem.”

Dr. Zhou Xiaochuan, Governor of the People’s Bank of China and the one of the nation’s leading macro thinkers, has put the Chinese currency issue to rest for the time being. “Now is not the time,” he said in an interview on the eve of the 5 February G-7 meeting in London when queried about China’s plans to adopt a more flexible foreign exchange regime. That puts an end to speculation of an imminent move and even draws into question my view that China is actively preparing to modify the decade-long peg between the renminbi and the dollar.

China takes the currency issue very seriously -- and rightfully so. As it weighs the pluses and minuses of alternative foreign exchange regimes, the over-arching considerations of “stability” appear to be dwarfing all other aspects of the internal debate. For an economy in the midst of extraordinary transition, the currency peg is thought to provide a financial anchor that an otherwise fragile financial system is lacking. China’s decision on the currency question is yet another reminder that it does not want to gamble in any way whatsoever when it comes to stability.

Yet the context is changing. China’s outward-looking development model is now increasingly intertwined with the rest of the world through trade, capital, and information flows. As such, China’s decision on the currency front -- which basically sets the relative price of the Chinese economy vis à vis the rest of the world -- has profound implications for the rest of us. That is especially the case with respect to the so-called “dollar adjustment” -- a realignment that many, myself included, believe is an important ingredient of global rebalancing. The problem is that the burden of the adjustment has been highly uneven. The euro has borne the brunt of the correction so far. The math is pretty compelling that the next bout of dollar depreciation simply will not occur unless Asia adjusts. Consequently, without yen and RMB appreciation, the case for a weaker dollar could be drawn into serious question -- a key reason why the dollar has rallied in the aftermath of Governor Zhou’s recent comments.

Interestingly enough, the world is convinced that China holds the key to the requisite Asian currency adjustment. I would point the finger more at Japan. The broad RMB index is only back to levels prevailing in early 2000 whereas the yen index is about 18% below the level of five years ago. At the same time, Japan’s current account surplus in 2004 was about four times that of China’s as measured in dollars. If anything, that tells me that there is considerably more scope for Japanese action on the currency front than is the case for China. This is yet another example of the consequences of China’s currency decision -- it unmasks tensions building elsewhere in Asia and the rest of the world.

These types of tensions are emblematic of what I believe are the most important consequences of China’s decision on the currency issue -- the risk of trade frictions and protectionism. Nowhere is that more evident than in the U.S., where legislation was just introduced in the U.S. Senate that would slap 27.5% tariffs on all Chinese products sold in America if the RMB were not revalued by a like amount. China is being singled out as the scapegoat for America’s huge trade deficit and its jobless recovery. Never mind the baseless nature of these claims. U.S. politicians just do not get the idea that budget deficits and the drag on national saving they produce are a major source of U.S. current account and trade deficits, that China does not set its currency on the basis of a bilateral trade imbalance with the U.S. but on the basis of its multi-lateral trade position -- which is in near balance, and that China’s peg means there has been no change in competitiveness relative to the dollar over the past decade. But that’s Washington. This debate is not about cause and effect.

China has never had a problem with the endgame of the currency debate. It has repeatedly stressed its desire to move to a more flexible foreign exchange mechanism. The key issue is when. A recent paper by the IMF’s China team raises a number of important questions about matters of timing -- concluding that it is in China’s best interest to move sooner rather than later to a more flexible currency regime. With $600 billion in foreign exchange reserves now at its disposal, China certainly has the wherewithal to limit excessive fluctuations that might arise in a more flexible currency regime. In the end, what do the experts really know? Advice is cheap, and it is always easy to offer it from the outside looking in. I have long been impressed by the wisdom of the Chinese leadership to stay the course and to do so by resisting, from time to time, the sage advice of outsiders. The Chinese economy barely flinched during the Asian crisis of 1997-98 for precisely that reason. The day will come when China realigns the flexibility of its policy structure with the flexibility of its newly reformed economy. China would far prefer to move in a constructive spirit rather than be pushed into a decision out of weakness and pressure.

Steeped in 5,000 years of inward-looking traditions, China has always had a hard time understanding its broader global role. The fast-changing pace of globalization only underscores this potential pitfall. By holding the line on the RMB peg, China is sending an important signal to an unbalanced world -- that stability at home outweighs its concerns over mounting global risks. Yes, the timing of any shift in its currency regime is entirely China’s prerogative. But that makes it all the more important for China and the rest of us to come to grips with the global consequences of these choices.

ANTI-IMF “THAKSINOMICS” ARE VINDICATED IN THAILAND

Thaksin Shinawatra claimed victory in Thailand’s national elections last Sunday, making Thai political history by becoming the first elected leader to win a second consecutive term in office. Exit polls showed Mr. Thaksi’s Thai Rak Thai (Thais love Thais) party won nearly 400 of the Parliament’s 500 seats an unprecedented margin in a country that spent much of the past 50 years governed by military dictators and fractious civilian coalitions. The exit poll projecting a Thai Rak Thai landslide was supported by early results, although the final tally is not expected to be known until the end of the week.

The Prime Minister’s most recent triumph, along with the country’s substantial economic recovery since he assumed office, surely validates the anti-IMF program he embraced during his tenure in government. If anyone needs to explain the success of “Thakinsonomics”, it is not the PM himself; the onus now falls on his many critics, whose dire predictions have thus far not come anywhere close to being fulfilled. Even those who acknowledge the success of Thai Rak Thai’s first term in office, do so in a very backhanded manner.

Even those who acknowledge the historic success of Asia’s alliance capitalism often maintain that it is sustainable only in an early phase of economic development and that the Asian financial crisis of 1997–98 showed that the kinds of relationships between state and big business fostered by the “developmental state” are prone to inefficiency and breakdown. By contrast, we have consistently argued in these pages that there was nothing fundamentally wrong with the Alliance capitalism model that could not be resurrected successfully. For all of the economic destruction meted out by the financial crisis of 1997, many of Thailand’s traditional attributes remained intact throughout the worst of the crisis: savings were high, inflation was low, and the country retained extraordinary rates of productivity. What Thaksin and his party recognized is that the Asian developmental state was based on very high savings, mostly by households.

Broadly speaking, Thailand’s crisis, indeed that of all of emerging Asia, was above all else a function of the mass withdrawal of short-term Western capital, rather than a symptom of a fundamentally flawed economic growth model. Indeed, the evidence of the past 10 years, particularly in places like Latin America, suggests that maximum integration into the world economy, and the concomitant absence of some form of industrial strategy, is a recipe for economic dislocation and disaster. Contrast the fates of Argentina in the 1990s with that of, say, China and India. While many economists continue to maintain that East Asia’s experience supports the proposition that liberalized markets are the best way to organize economies, developed or developing (and thereby implicitly seek to discredit the model embraced by Thailand’s re-elected government), such assertions fly in the face of much evidence to the contrary.

Thaksin’s implementation of a 3-year moratorium on agricultural debts and his proposal to create a national asset management company to purchase large debts held by the country’s banks took bad debts off the latter’s hands and thereby arrested a mounting deflationary debt dynamic during which these loans were liquidated. To avoid precisely these kinds of deflationary outcomes Anglo-American nations long ago agreed that the state had to create a lender of last resort and a body of regulation that placed limits on the indebtedness of private banks, firms, and households. Yet when the Thaksin administration sought to do the same, it was deemed to be a form of economic deviancy.

The truth of the matter is that the severity of the Asia crisis and its timing (the fact that it took place in 1997 and not, say, 1993), can be explained by the conjunction of several factors that suggest that financial deregulation and the unstrategic opening of the capital account were decisive factors in the build up to crisis and in the intensity of the subsequent slump. Those who pushed for it without constraining their push by the capacity of the financial regulatory apparatus on the ground -- Wall Street investment banks, the U.S. Treasury, the IMF, and segments of domestic policy elites -- acted with gross irresponsibility.

The case of Thailand under the Thaksin administration shows how governments can -- even in conditions of a globalized world economy and even when subject to real democratic accountability -- impart directional thrust to an economy in line with the exercise of foresight about the country’s future growth. The remarkable thing about those critics of the Thai Prime Minister who continue to promote the classic market fundamentalist line is the gulf between the confidence with which they promulgate this view and the strength of (or, to be more precise, lack of) supporting evidence, historical or contemporary. One can only presuppose that there is a hidden agenda at work: the more figures such as Thaksin and his ilk succeed, the more they starve the core Washington Consensus of any remaining legitimacy and, by extension, the multilateral institutions formulated to perpetuate this system. Fortunately, cases like Thailand show that there is a worthy alternative.

MAJOR LEAGUE DEBTORS

The ranks of BBB- credits are a lot like AAA baseball teams. Both groups include “players” that are not quite Big League material -- either because their talents are diminishing or because their talents are not yet fully developed. Or perhaps, because they never really possessed much talent in the first place. In other words, the ranks of BBB- credits and AAA ball clubs contain both “has-beens” and “up-and-comers”. In the AAA, for example, 30-something former big leaguers play side-by-side with 20-something prospects. BBB- credits include an equally diverse collection of players. Thus, we find in the ranks of BBB- credits the curious juxtaposition of General Motors and the Russian Government. These two borrowers may be BBB- “teammates”, but we doubt they will be on the same team for long.

General Motors, the has-been of our metaphor, once boasted a formidable AAA credit rating, just like the U.S. Treasury itself. Throughout the 1970s, while GM was busily responding to the Arab oil embargo by churning out yacht-sized Cadillac Fleetwoods, the automaker was able to borrow money at preferred AAA rates. In 1981, however, the company’s downward slide “officially” began, as S&P dropped GM’s rating to AA+. Today, the beleaguered American icon’s debt rating sits just one downgrade away from “junk” status.

By contrast, the Russian government had never managed to earn an investment-grade rating ... until a few weeks ago. Like a career minor leaguer, the Russian government’s credit rating bounced around in the junk ranks for several years. Then, in 1998, this troubled borrower validated its lowly rating by defaulting on its sovereign foreign debts. This ignominious event -- otherwise known as the “Russian debt crisis” -- marked the nadir of Russia’s post-communist economic odyssey. But it has been recovering steadily ever since. Aided by a doubling of the oil price, the Russian economy has clawed its way back to international respectability, finally garnering an “investment grade” rating from S&P late last month.

But what lies ahead for Russia and General Motors? Which of these two marginal credits will advance to the big leagues and which will fall even deeper into the minors? To formulate a guess, we will need to take a brief look at their respective stat sheets. This morning, we will go under the hood of GM. Next week, we will turn the spotlight on the Russians...

GREENSPAN’S WHOPPER

For years, we have been working on Greenspan’s obituary. As far as we know, the man is still in excellent health. But we do not want to be caught off guard. Maybe we could even rush out a quickie biography, explaining to the masses the meaning of Mr. Greenspan’s life and work. We see something in Alan Greenspan’s career ... his comportment ... his betrayal of his old ideas ... his pact with the Devil in Washington ... and his attempt to hold off nature’s revenge at least until he leaves the Fed ... that is both entertaining and educational. It smacks of Greek tragedy without the boring monologues or bloody intrigues. Even the language of it is Greek to most people. Though the Fed chairman speaks English, of course, his words often need translation and historical annotation. Rarely does the maestro make a statement that is comprehensible to the ordinary mortal. So much the better, we guess. If the average fellow really knew what he was talking about, he would be alarmed.

The background: The U.S. economy faced a major recession in 2001 and had a minor one. The necessary slump he held off by a dramatic resort to central planning. The “invisible hand” is fine for lumber and poultry prices. But at the short end of the market in debt, Alan Greenspan’s paw presses down, like a butche’qs thumb on the meat scale. The Fed quickly cut rates to head off the recession. Indeed, never before had rates been cut so much, so fast. George W. Bush, meanwhile, boosted spending. The resultant shock of renewed, ersatz demand not only postponed the recession; it misled consumers, investors and businessmen to make even more egregious errors. Investors bought stock with low earnings yields. Consumers went further into debt. Government liabilities rose. The trade deficit grew larger. Even on the other side of the globe, foreign businessmen geared up to meet the phony new demand; China enjoyed a capital spending boom as excessive as any the world has ever seen.

What the Greenspan Fed had accomplished was to put off a natural, cyclical correction and transmogrify an entire economy into a monstrous ECONOMIC bubble. A bubble in stock prices may do little real economic damage. Eventually, the bubble pops and the phony money people thought they had disappears like a puff of marijuana smoke. There are winners and losers. But in the end, the economy is about where it began -- unharmed and unhelped. The households are still there, and still spending money as they did before. And the companies still in business. Only those that leveraged themselves too highly in the bubble years are in any trouble -- and they probably deserve to go out of business.

Even a property bubble may come and go with little effect on the overall economy. House prices have been running up in France, for example, at nearly the same rates as in America. But in France there is very little mortgage refinancing, or “taking out” of equity. The European Central Bank was repeatedly urged to lower rates in line with those in America. It refused to budge. Without falling rates, there was no “refi boom”. Nor were European banks offering “home equity lines of credit”. Property could run up and run down, and the only people who cared would be the actual buyers or sellers, who either cursed themselves or felt like geniuses, depending on their luck.

But in Greenspan’s bubble economy something remarkably awful happened. Householders were lured to “take out” the equity in their homes. They believed that the bubble in real estate priced created “wealth” that they could spend. Many did not hesitate. The average household’s debt increased by $30,000. Americans still lived in more or less the same houses. But they owed far more on them.

We had given up all hope of ever getting an honest word out of the Fed chairman on this subject when, in early February, in the year of our Lord 2005, the maestro slipped up. His speech was entitled “Current Account”. Jet lagged, his defenses down, the poor man seems to have committed truth. “The growth of home mortgage debt has been the major contributor to the decline in the personal saving rate in the United States from almost 6 percent in 1993 to its current level of 1 percent,” he admitted. Mr. Greenspan lowered lending rates far below where a free market in credit would have put them. With little to be gained by putting money in savings accounts, and a lot to be gained by borrowing, households did what you would expect; they ceased saving and began borrowing. What did they borrow against? The rising value of their homes.

“Approximately half of equity extraction shows up in additional household expenditures, reducing savings commensurately and thereby presumably contributing to the current account deficit. ... The fall in U.S. interest rates since the early 1980s has supported home price increases,” continues America’s answer to Adam Smith. People take money out of their homes. With this source of spending power available to them, they see no reason to save. Instead, they spend -- often on foreign-made goods. With no savings available domestically, America must look overseas for credit.

The crime of which Mr. Greenspan is guilty is fraud. Putting interest rates at an artificially low level, the Fed chairman intentionally misled Americans. Were it not for the Fed’s low rates and easy lending policies, Americans would not have thought themselves so rich. Their houses would not have gone up so much; they would not have taken out so much equity, because they would not have had any equity to take out. They would have had to spend less, which would have reduced the U.S. current account deficit and diminished household indebtnedness. “At long last, Chairman Greenspan owns up to the central role he and his colleagues at the Federal Reserve have played in fostering these developments,” comments Stephen Roach.

Our own Fed chairman, guardian of the nation’s money ... custodian of its economy ... night watchman of its wealth... How could he do such a thing? And yet he has done it. He turned a financial bubble into an economic bubble. Not only were the prices of financial assets ballooned to excess, so were the prices of houses, and so were the debts of the average household. Where does it lead? The force of a correction is equal to the deception that preceded it. Mr. Greenspan’s whopper must be followed by a whopper of a slump.

CONFESSIONS OF AN ECONOMIC HIT MAN

How the U.S. Uses Globalization to Cheat Poor Countries Out of Trillions

John Perkins describes himself as a former economic hit man -- a highly paid professional who cheated countries around the globe out of trillions of dollars. 20 years ago Perkins began writing a book with the working title, “Conscience of an Economic Hit Men”. Perkins writes, “The book was to be dedicated to the presidents of two countries, men who had been his clients whom I respected and thought of as kindred spirits -- Jaime Roldós, president of Ecuador, and Omar Torrijos, president of Panama. Both had just died in fiery crashes. Their deaths were not accidental. They were assassinated because they opposed that fraternity of corporate, government, and banking heads whose goal is global empire. We Economic Hit Men failed to bring Roldós and Torrijos around, and the other type of hit men, the CIA-sanctioned jackals who were always right behind us, stepped in.

John Perkins goes on to write, “I was persuaded to stop writing that book. I started it four more times during the next twenty years. On each occasion, my decision to begin again was influenced by current world events: the U.S. invasion of Panama in 1980, the first Gulf War, Somalia, and the rise of Osama bin Laden. However, threats or bribes always convinced me to stop.” But now Perkins has finally published his story. The book is titled Confessions of an Economic Hit Man.

Says Perkins, “Basically what we were trained to do and what our job is to do is to build up the American empire. To bring -- to create situations where as many resources as possible flow into this country, to our corporations, and our government, and in fact we’ve been very successful. We’ve built the largest empire in the history of the world. It’s been done over the last 50 years since World War II with very little military might, actually. It’s only in rare instances like Iraq where the military comes in as a last resort. This empire, unlike any other in the history of the world, has been built primarily through economic manipulation, through cheating, through fraud, through seducing people into our way of life, through the economic hit men. I was very much a part of that.”