Equity Market to Continue its Path of Correction?

The equity market took the news of the negative U.S. credit outlook rather hard yesterday. Even before that news, a lot of stocks, especially those commodities related stocks (except for precious metals) had corrected quite significantly.

I've been saying for the last three years that this economic crisis is quite different from the previous ones that we've experienced such as the burst of the dot com bubble. The logic is simple: it was the governments around the world that always came to the rescue whenever recessions hit the economies. However, due to deteriorating fiscal situations of those sovereign states (especially many European states and the U.S), governments will be forced to cut back their spending on social safety nets and various types of government programs in an effort to trim down their debt loads (part of which they incurred to save failing financial institutions few years ago).

To add insult to the injury, the two biggest economies (the U.S. and the European Union) are in trouble. In previous economic crises, it was the U.S. and the EU nations that were able to buy goods produced from the rest of the world (including the countries going through economic crises), thereby helping these nations to get out of the economic crises. 

Possible layoffs of government employees and reduced government spending around the world will put deflationary pressures on the economy. As a result, coupled with the already well known European debt crisis, we could see another run for the safety, and the US dollar, bullion and Treasuries can appreciate, while commodities will be hammered. 

Central banks around the world will continue to face a difficult dilemma. Their liquidity injections to curve the economic recession are now slowly coming back in a form of inflationary pressure. However, it will be a lot tougher to react as increased interest rates will put a lot higher pressures on debtor nations and households in financing the debts. 

The news on a possible Greek debt restructuring had the yield react very severely. Any debt restructuring or default by any one of the troubled European nations will directly hit the banking system as a lot of creditors are European banks and other European sovereign states that also owe money to other parties. In other words, the tightly connected and interdependent financial systems around the world will be affected. 

Stay tuned because this time is really different in my opinion. 

p.s. in the long run, however, central banks around the world will try to monetize their debts and unfunded liabilities (especially in the US) that investors will be worse off owning cash and government bonds in the long run in my opinion. 

China Crops in Short Supply as Fewer Farms Spur Food Futures

Across the road from Zhao Yuanyi’s wheat field in China’s Shandong province, Chonche Group is expanding a rail-car factory on what used to be 227 hectares of farms. Nearby,Geely Automobile Holdings Ltd. (175) makes sedans on an 87 hectare site that four years ago was covered by crops.

The factories sprawling from Jinan city, 350 kilometers (220 miles) south of Beijing, put Zhao on the front line of a clash between a policy of food self-sufficiency and industrial growth that made China the world’s second-biggest economy. Industrialization is winning, signaling prices for crops like wheat and corn will rise as China is increasingly unable to feed itself and vies for supplies on global markets.

“This year, maybe next, they’ll develop my field,” Zhao, 63, explains as he stands beneath a China Mobile Ltd. cell-phone tower on the edge of the land he’s tended all his life. The local government will buy his land, paying compensation through an annual allowance of 1,800 yuan ($276) per mu, which amounts to about 2,700 yuan for each person in the village.

China’s farmland shrank by 8.33 million hectares (20.6 million acres) in the past 12 years, Premier Wen Jiabao’s top agriculture adviser Chen Xiwen told reporters March 24. Land under cultivation has already fallen almost to the government’s 120 million hectare limit after being consumed by apartments, factories, desertification and a forestation campaign. Drought has also hit the country’s main wheat-growing region.

“China’s increased demand for agricultural commodities will mean an increase in prices for the entire world market,” said David Stroud, chief executive officer of New York-based hedge fund TS Capital Partners. “China can outlast any other bidders for the commodities it desires.”

Price Forecasts

Investors should bet on crops in shortest supply in China, with wheat and corn now offering the best opportunities, he said.

Wheat futures in Chicago may average $8.05 a bushel this quarter, 89 percent higher than the past year’s low, as farmers struggle to rebuild global stockpiles, according to Rabobank International’s Agri Commodities Monthly e-mailed April 18. Corn futures may reach a record, jumping to as high as $10 a bushel, Alex Bos, an analyst at Macquarie Group Ltd. said April 6.

“As China continues to grow, demand and supply will struggle to keep up,” said Abah Ofon, a Singapore-based commodities analyst at Standard Chartered Plc. “This would be a problem for any country. For China, the world’s biggest consumer and producer, a small deficit can result in huge demand for imports.”

Riots, Poverty

A 5 percent shortfall in China’s overall grain harvest would potentially require 20 percent of current global grain exports to meet the country’s annual needs, Ofon said. Wheat in Chicago reached its highest level since 2008 in February on concern drought was damaging China’s crop, raising the risk the country would drain the world market.

Rising food prices cause riots and civil conflict, and widen the gap between rich and poor, according to an International Monetary Fund working paper by economists Rabah Arezki and Markus Brueckner published last month on the organization’s website. World Bank President Robert Zoellick said in February that the price surge was “an aggravating factor” in uprisings sweeping the Middle East.

Hong Kong-listed Geely and closely held Chonche are using land that China needs to offset shortfalls in more developed areas. The spread of cities and factories in wetter grain- growing coastal regions such as Jiangsu and Zhejiang has put more pressure on drier provinces like Hebei and Shandong.

“Food production is increasingly being focused in northern areas that have water shortages,” agricultural adviser Chen wrote in December. That’s “very worrying for food security.”

Wen Focus

Wen has pledged to rein in food costs and has said that inflation, which threatens social stability, was the government’s top priority.

Scope for raising yields my be limited as wheat farmers in China are already 51 percent more productive than their American counterparts per land area, according to data from theDepartment of Agriculture in Washington.

While investment in irrigation and technology such as genetically modified crops may boost that, land and water shortages and migration of labor to cities is putting grain production “on a shaky base,” said Qian Keming, head of the Agriculture Ministry’s market and economic information division.

“With rising living standards, and more consumption of meat, eggs and dairy produce, grain consumption is inevitably on the rise,” Qian said.

Chicken, Pork

The Chinese ate 20 percent more chicken last year than in 2006, while pork consumption rose almost 11 percent, USDA data show. It takes 2 kilograms of feed to produce one kilogram of chicken, and about double that for pork, according to the Washington-based Earth Policy Institute.

China, the world’s biggest grain producer, was a net exporter of soybeans until 1995. This year it’s forecast to import 57 million tons, or almost 60 percent of global trade in the oilseed used in animal-feed and tofu.

Archer Daniels Midland Co., Bunge Ltd. (BG) and Cargill Inc. were among U.S. food companies that in January won $6.68 billion of deals to supply China with soybeans, the U.S. Soybean Export Council said.

China’s imported food as a percentage of domestic consumption is “tiny” at about 3 percent, saidFrederic Neumann, a Hong Kong-based economist for HSBC Holdings Plc. “If you doubled that to 6 percent, that implies enormous purchases on the world market. The guy with the most financial firepower is going to drive up the price and smaller countries are just going to have to cough up.”

Global Shortage

Global food output will have to climb 70 percent between 2010 and 2050 as the world population swells to 9.1 billion people and rising incomes boost meat and dairy consumption, the UN’s Food and Agriculture Organization said last year.

Soybean futures in Chicago are up about 37 percent in the past year. Wheat is up 70 percent, while corn more than doubled.

By 2015, 51.5 percent of China’s population will live in towns and cities, Wen said in March. That’s up from 36 percent in 2000, World Bank data show. China’s population is currently more than 1.3 billion.

Growth of cities in China is part of a global trend pushing up food prices, said Jeffrey Currie, London-based head of commodities research at Goldman Sachs Group Inc.

With acceleration in demand because of “urbanization and the shift in diet to more protein, we need to grow more acreage,” Currie said in February in Hong Kong. The trouble is, “we have a finite amount.”

Illegal Use

China’s farmland per capita is less than half the world average, and one-sixth that of the U.S., according to China Comment, a Communist Party magazine. Actual land loss may be greater than the government’s numbers suggest, as local officials fudge figures and illegal use proliferates.

The Land Ministry said there were 53,000 cases of illegal land use in 2010, including factories, industrial parks and golf courses. Demand for land was more than double the 400,000 hectares the government allocated, according to the ministry.

Local governments made 2.7 trillion yuan in 2010 selling rights to farmland for non-agricultural purposes, with total land sales constituting 60 to 70 percent of revenue, according to Landesa, a Seattle-based organization that works to secure land rights for the poor.

A few villages north of Zhao’s field, Zhao Daochun, 43 and who is no relation, was supervising a team of 10 men building a factory on what used to be 2 hectares of fields. His boss wouldn’t tell him what the building would be used for, he said.

Forced to Sell

About 120 kilometers south, near Qufu, the home of Confucius, wheat farmer Hu Bo, 36, said officials forced villagers to sell about 33 hectares of land to build a coal- washing factory that’s now shuttered.

“The officials don’t give a damn if the business is profitable,” Hu said. “They just want to receive kickbacks from investors who get the money from banks and probably don’t care much about profitability either.”

“I don’t know what I’ll do” once the land has been rezoned, said Zhao Yuanyi.

To contact the editors responsible for this story: Peter Hirschberg atphirschberg@bloomberg.net; James Poole at jpoole4@bloomberg.net

Zhou Says $3 Trillion China Reserves Have Risen Beyond ‘Reasonable’ Level

China’s foreign-exchange reserves have exceeded a “reasonable” level and the management and diversification of the holdings should be improved, central bank Governor Zhou Xiaochuan said.

Increases in the holdings, which topped $3 trillion in March, are putting pressure on central-bank operations that withdraw money from the financial system, Zhou said after a speech atTsinghua University in Beijing late yesterday. Zhou spoke of the need to reduce an excessive accumulation of reserves, using a Chinese word that could refer to either existing holdings or the pace of the build-up.

The reserves climbed $197 billion in the first quarter, reflecting global imbalances that Group of 20 finance ministers agreed last week to address through deeper scrutiny of their economic policies. China’s surging holdings are fueling inflation that accelerated last month to the highest in 32 months, prompting the government to boost banks’ reserve requirements this week for the fourth time this year.

“Foreign-exchange reserves have exceeded the reasonable levels that we actually need,” Zhou said. “The rapid increase in reserves may have led to excessive liquidity and has exerted significant sterilization pressure. If the government doesn’t strike the right balance with its policies, the build-up could cause big risks,” he said, without elaborating.

Investment Inflows

Foreign direct investment into China jumped 33 percent to $12.5 billion last month from a year earlier, the commerce ministry said today. The world’s second-biggest economy grew 9.7 percent in the first quarter from a year earlier, faster than economists had forecast, and consumer prices climbed 5.4 percent in March, the government said last week.

The nation’s currency holdings jumped by the second-biggest amount on record in the January to March period, even as the nation reported its first quarterly trade deficit in seven years. Economists attributed much of the increase to capital inflows betting on appreciation of the yuan.

The funds have added to the liquidity that’s flooded the economy over the last two years as the government encouraged an unprecedented lending boom to support growth amid the global financial crisis.

Zhou said speculative inflows of funds are not a major concern given that China is a large economy which maintains controls on capital flows for investment purposes. Still, liquidity is excessive and the government needs to “remain vigilant” over the property market and take “counter- cyclical” measures to curb surging real-estate prices, he said.

Diversifying Investment

Diversifying the nation’s reserves through investment agencies such as China Investment Corp., the country’s sovereign wealth fund, is a consideration, Zhou said, while declining to answer questions on whether CIC will receive more capital from the nation’s foreign-exchange holdings.

CIC’s Chairman Lou Jiwei said the fund may get more capital to invest in overseas markets, China National Radio reported on April 17.

“One option is to consider some new types of investment agencies which focus on new investment areas,” Zhou said. “It’s inappropriate for me to detail the next stage of the plan, but the direction is clear.”

Fitch Ratings lowered its outlook on China’s AA- long-term local-currency rating to negative from stable last week, the first time in 12 years the nation’s debt rating faces a cut. Fitch said there was a “high likelihood of a significant deterioration” in banks’ asset quality after a record jump in lending in the last two years.

Moody’s Outlook

Moody’s Investors Service also lowered its outlook on China’s property industry to negative from stable on concern residential sales could decline by as much as 30 percent as local governments enforce housing curbs.

“The ratings given by international credit agencies shouldn’t be taken too seriously,” Zhou said. “They may have good insights on many projects and companies but it’s hard for me to comment on their sovereign ratings,” he said in response to questions about the revisions.

Loans to companies and households in China rose to about 140 percent of gross domestic product last year from 111 percent in 2008, Fitch said. Much of the increase was linked to property lending and credit to the financing vehicles of local governments who aren’t allowed to issue bonds.

Zhou said today that letting local authorities sell debt, whose repayment could be partly supported by property tax revenues, is a subject that “merits discussion” although such a move would require a change in the law.

The ability of domestic financial markets to adequately price such debt also needs to be studied, he said.

--Victoria Ruan. Editors: Nerys Avery, Fergal O’Brien

To contact Bloomberg News staff on this story: Victoria Ruan in Beijing at +86-10-6649-7570 or vruan1@bloomberg.net;

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

Kenny Says Ireland Won't Default on Debt as Greece Investor Concerns Mount

Irish Prime Minister Enda Kenny said the nation won’t default on its debt as he tries to rebuild confidence at a time when investors speculate Greece may struggle to pay back its borrowings.

“The Greek government will obviously deal with this problem in the best way it can,” said Kenny, 59, in an interview withAndrea Catherwood on Bloomberg Television’s “Last Word” inLondon today. “We have no intention of defaulting. We’ve made that perfectly clear. We want to continue to pay our way.”

Irish, Greek and Portuguese bonds fell today amid mounting speculation Greece will have to restructure its debt. All three countries have sought bailouts from the European Union andInternational Monetary Fund, and Kenny’s government wants a reduction on the rate on its loans, which he has described as “too severe.”

“We’re not looking for more money from Europe, we’re looking for greater flexibility,” Kenny said, referring to the rate on the bailout and to medium-term financing for lenders from theEuropean Central Bank. He also said that an increase in Ireland’s 12.5 percent corporation-tax rate to appease fellow EU leaders is “not up for negotiation.”

Ireland’s government last month pledged to inject additional capital of as much as 24 billion euros ($34 billion) into lenders after mounting losses forced the country ask for external help in November. Finance Minister Michael Noonan said on April 8 it’s important to reach an agreement on lower bailout rates before the country taps “serious tranches of money.”

Bonds Fall

Kenny said that Anglo Irish Bank Corp., which is being wound down, may not need further capital. Ireland has injected 29.3 billion euros into the nationalized lender over the past two years. He also said its senior bondholders may be treated differently than those at Allied Irish Banks Plc (ALBK) and Bank of Ireland Plc, which the government says won’t have losses imposed on them.

“The indications are that it won’t need extra capital,” Kenny said, ahead of a planned update in May on the cost of bailing out Anglo Irish and smaller rival Irish Nationwide Building Society. “We’ve made it perfectly clear that senior bondholders in Anglo Irish and INBS” are a “different category” to those in Ireland’s other banks, he said.

Irish bonds fell today, pushing the yield on the country’s 10-year debt to 9.76 percent at the close of trading in London, the highest in two weeks. The yield on Greek and Portuguese bonds of the same maturity rose to euro-era records. European shares declined, with the Stoxx Europe 600 Index dropping 1.7 percent.

Kenny said Ireland’s government has “plenty of time” before interest payments due in October or November “to demonstrate the seriousness of intent” about tackling the country’s banking and fiscal problems.

“We believe that growth projections and initiatives that were taken will lead Ireland to a position where we fix what’s been broken” and generate economic growth, he said.

To contact the reporters on this story: Joe Brennan in Dublin at jbrennan29@bloomberg.net; Andrea Catherwood in London at acatherwood@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net