Two articles published Wednesday in the Financial Times of London echoed leading themes in American Theocracy: The Perils and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century (Viking, 2006), the new bestseller that UFPPC's Monday evening book discussion circle "Digging Deeper" is studying this month.  --  Both pertain to what Kevin Phillips calls "the financialization of America."  --  By that term he refers to the fact that the so-called FIRE industries (finance, insurance, and real estate) have become economically dominant, accounting for 21% of the GDP in the U.S.  --  Inclined to agree with Phillips's view that this development is problematic for the health of American society (and therefore global society, which is dominated by the state of the U.S. economy) is Andrew Glyn, author of Capitalism Unleashed, published this month by Oxford University Press.  --  Glyn, an economics fellow at Corpus Christi College, Oxford, points out the "U.S. financial companies earned 10-15 per cent of total U.S. corporate profits in the 1950s and 1960s, but now account for 30-40 per cent of the total.  If profits from the financial activities of industrial and commercial companies are included, finance in this broader sense could soon account for a majority of U.S. corporate profits."  --  Glyn warns that "the financial sector itself is a potential source of disastrous instability."  --  Glyn suggests that there must be limits to the ability of U.S. consumers to absorb more debt as a means of staving off recessions.  --  He also suggests that the overinvestment in telecommunications during the Dot-com bubble and the near-collapse in 1998 of Long Term Capital Management, supposedly managed by "the best finance faculty in the world," are indicators of the irrationality in the present financial system.  --  Even the stability of the recent decade can be regarded as an ominous factor, since "[s]table economic conditions themselves encourage greater risk-taking."  --  Glyn's cautionary note offers no specific suggestions, though, either for governments or individuals.  --  In another piece published Wednesday in the Financial Times, Philip Johnson reported that "suspicion that the interest rate differential, the factor that has driven the currency market for the past 16 months, is starting to lose its power" has led to "fevered speculation as to what the new drivers of the forex market are," which have produced steady gains for the euro over the past year.  --  The solution to the mystery, according to Johnson, is that the euro is not the dollar: "Most explanations are based on fears over the ever-growing U.S. current account deficit. . . . The consensus view is that this deficit, now about 7 per cent of gross domestic product, can only return to a more sustainable level if and when the dollar falls steeply. . . . In this environment, the euro revels in its dual status as the “un-dollar”, the most liquid alternative currency for dollar bears to move into.  --  Rising oil prices, which will merely widen the U.S. deficit further, have lent more support to the un-dollar. . . . Sweden, Russia, Qatar, Kuwait, and the United Arab Emirates all having either reduced their dollar exposure or talked about doing so in recent weeks."  --  The weakness of the dollar vis-à-vis the euro (and the absence of any real plan on the part of an increasingly faith-based American leadership to deal with it) is also a theme explored by Kevin Phillips in American Theocracy....
1.

Comment & analysis

Comment

FINANCE'S RISE THREATENS ECONOMIC STABILITY
By Andrew Glyn

Financial Times (UK)
April 26, 2006

http://news.ft.com/cms/s/d5a4c0d2-d54a-11da-93bc-0000779e2340.html (subscribers only)

Adam Smith described money as the “great wheel of circulation.” By facilitating economic expansion, the financial system plays its part in raising living standards. For these functions the banks have always taken their cut. However, this has increased dramatically in recent decades. U.S. financial companies earned 10-15 per cent of total US corporate profits in the 1950s and 1960s, but now account for 30-40 per cent of the total. If profits from the financial activities of industrial and commercial companies are included, finance in this broader sense could soon account for a majority of US corporate profits.

This trend for finance to grow much faster than the “real” economy is also apparent in the U.K. and elsewhere. In return for absorbing a rising share of society’s resources, especially highly qualified workers, what is being delivered in return?

U.S. consumers have recently buttressed expansion in the world economy, and the rise of consumer and mortgage credit has played a decisive role in pushing U.S. consumption to the point where households have stopped saving. But what finance provides it can also take away. Consumer credit may stave off recessions if increased lending allows consumers to keep spending when income growth slows. But it can also make recessions worse if they are forced to repay debts in a downturn, as the examples of Sweden or the U.K. in the early 1990s showed.

A sophisticated financial system is supposed to encourage capital accumulation. The massive real investments in telecommunications during the internet boom seem an excellent example. By 2002, however, less than half of the U.S. telecoms capacity was being used. Michael Jensen, a finance academic and proselytiser for the drive for shareholder value, noted bitterly that investment banks had played their part in the “catastrophic overvaluation” of stock markets by contributing to the “misinformation and manipulation” that fed it. If this process was the “creative destruction” that Joseph Schumpeter described, then the scales came down heavily on the destructive side.

After the bust, capital stock growth in the U.S. fell more steeply than in any post-war recession. Throughout the Organization for Economic Co-operation and Development countries, capital stock has been growing at barely 2 per cent a year since 2000. This is less than half the growth rate of the 1960s when the financial sector was tightly constrained, and lower than in the 1970s, when macroeconomic conditions were turbulent.

In the U.K. the City of London occupies a special position. The financial services sector is often promoted as a key factor in the balance of payments, helping to fill the gap left by enfeebled manufacturing. In fact this contribution is quite modest. In 2005 overseas earnings from the provision of insurance, banking, and other financial services was about £21bn ($38bn), only one-tenth of earnings from exporting goods.

In spite of the talent involved in devising ever more sophisticated trades, the financial sector itself is a potential source of disastrous instability. When Merton Miller, the finance theorist, received the Nobel Prize for economics in 1997, his autobiographical notes recalled that Institutional Investor magazine had characterized his colleagues at Long Term Capital Management as “the best finance faculty in the world.” A year later LTCM, a trail-blazing hedge fund, had to be rescued from bankruptcy by a consortium organized by the New York Federal Reserve, amid fears that its collapse could lead to big financial markets seizing up. A recent study of hedge funds by Nicholas Chan and colleagues suggested systemic risk -- the possibility of a series of correlated defaults among financial institutions -- was “currently on the rise.” An assessment in 2004 by William White, head of the monetary and economics department of the Bank for International Settlements, drew the alarming conclusion that “The modern financial system seems to be subject to a wide range of problems: operational disruptions, institutional insolvencies, short-term market volatility, medium-term misalignments, and contagion across countries and markets.”

All these fears aside, the past decade has seen the least volatile output growth of any decade since 1950. Does this refute the argument that the rise of finance threatens greater economic instability? Such a conclusion would be too complacent. Stable economic conditions themselves encourage greater risk-taking. Financial innovation may have thickened the financial elastic. But it is becoming more and more tightly stretched. Who can be confident that it will not snap?

--The writer, author of Capitalism Unleashed (Oxford University Press), teaches economics at Oxford University.

2.

Markets

Investor's Notebook

EURO REVELS IN ITS POSITION AS THE 'UNDOLLAR'
By Steve Johnson

Financial Times (UK)
April 26, 2006

http://news.ft.com/cms/s/39226e5a-d53e-11da-93bc-0000779e2340.html (subscribers only)

Almost overlooked among the fluctuations of the dollar and the travails of the yen, the euro has made sure but steady gains this year.

Europe’s shared currency hit the latest in a series of seven-month highs against the dollar yesterday. Its peak of $1.2459 cemented a 6.7 per cent rally from November’s lows.

The euro also hit a lifetime high of Y145.29 against the yen last week, as well as notching 15-month and five-year peaks respectively against sterling and the Swiss franc earlier this month. Unsurprisingly, this has pushed the trade-weighted euro to a seven-month high.

Quite why the euro should have performed so well is a little less straightforward, although the currency has clearly benefited from signs of a long overdue pick-up in the sluggish eurozone economy.

Germany’s IFO business sentiment index for April came in at a 15-year high this week, the most recent eurozone manufacturing purchasing managers’ index outstripped its U.S. equivalent for the first time in three years and inflation in the 12-nation bloc has remained consistently above the European Central Bank’s target of close to 2 per cent.

This modest recovery allowed the ECB to raise rates in both December and March. Many analysts now expect another three more quarter-point increases before the year is out, taking rates to 3.25 per cent.

With the market now pricing in only one or two more rate rises in the U.S. this year, one view is that the euro is benefiting from improving yield differentials against its peers, particularly against the yen given the forecast slow pace of Japanese monetary policy tightening.

Yet analysts suggest this cannot be the whole story. So far this year, neither two- or 10-year U.S./eurozone bond spreads have narrowed one iota, with yesterday’s two-year spread at 157 basis points and the 10-year gap at 110 points.

“The movements in spot rates do not reflect the minor changes in rate markets,” says Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi UFJ.

This has led to suspicion that the interest rate differential, the factor that has driven the currency market for the past 16 months, is starting to lose its power. This in turn has engendered fevered speculation as to what the new drivers of the forex market are, and quite why the euro has performed so strongly against the dollar.

Most explanations are based on fears over the ever-growing U.S. current account deficit, the primary cause of the dollar’s three-year sell-off up to 2004.

The consensus view is that this deficit, now about 7 per cent of gross domestic product, can only return to a more sustainable level if and when the dollar falls steeply. Deficit concerns were always likely to return to center-stage once the end of U.S. monetary tightening neared, and recent statements from the G7 warning of the dangers of global economic imbalances have helped push the issue higher up the agenda.

In this environment, the euro revels in its dual status as the “un-dollar,” the most liquid alternative currency for dollar bears to move into.

Rising oil prices, which will merely widen the U.S. deficit further, have lent more support to the un-dollar. Hans Redeker, head of currency strategy at BNP Paribas, reports a 93 per cent correlation between oil prices and euro/dollar rates since hurricane Katrina struck last autumn.

But most explanations feature that old chestnut of central bank diversification, with Sweden, Russia, Qatar, Kuwait and the United Arab Emirates all having either reduced their dollar exposure or talked about doing so in recent weeks. Rising oil prices, which leave oil exporters with more dollars to convert into euros, play into this theme.

Mr. Redeker also sees the Middle East behind recent moves. With further diversification to come, he predicts the euro will hit a lifetime high of $1.38 next year.

Tony Norfield, global head of FX strategy at ABN Amro, also sees the euro taking on the burden of dollar weakness. The G7 may be most keen for the dollar to fall against Asian currencies but with Asia likely to shout loudest about currency strength, a stronger euro may, not for the first time, prove the path of least resistance.