Now, "The End of the Middle" of the Financial Crisis

We've gradually crept back into equities in the past month as we've blogged that the financial crisis has moved from "the beginning" to "the beginning of the middle." We now think a new milestone has been reached: we've progressed to "the end of the middle." (We're just one-step closer to the ultimate buy-signal, "the beginning of the end.")

So, what's changed? There are now many more reasons for the Fed to diminish the pace of its rate cutting, the most important of which is that the financial crisis appears to be easing by many indicators. Furthermore, the main global disaster scenario is premised on a U.S. dollar that weakens to oblivion -- If the Fed is able to diminish its rate-cutting pace, the dollar will find a fresh source of support to reduce the chances of a dollar melt-down. All of this could well combine to moderate commodity prices for a while, and that would be a crucial element in a more stable macro-economic outlook -- a necessary condition for restoring more of a balance that most securities markets will find bullish.

In other words, we continue to "muddle through" the financial crisis, which is the bullish scenario for equities. We still face a potentially uncomfortable global economic slowdown that will raise additional risks, such as that of a Developing Market crisis in some areas. That, in our view, would signal the real "beginning of the end" of the crisis, and a very good buying opportunity in equities.

The following Bloomberg article summarizes why we believe the financial crisis has taken a step toward ultimate resolution:

• Commodities Tumble Most in Five Weeks After Dollar Rebounds, by Ron Day

  April 29 (Bloomberg) -- Commodities fell the most in five weeks as a rally by the dollar eroded demand for energy, metals, crops and livestock as alternative investments.

  The weighted UBS Bloomberg Constant Maturity Commodity Index fell 1.9 percent to 1,508.21 at 4:11 p.m. New York time, the biggest drop since March 19. Wheat prices tumbled to a five- month low, crude oil slid more than $3 a barrel and silver dropped almost 3 percent.

  The dollar was poised for the first monthly advance against the euro this year on speculation the Federal Reserve will signal that it has finished lowering U.S. interest rates after six reductions since September. A week ago, the dollar plunged to a record against the euro, boosting demand for raw materials as a hedge against inflation.

  ``This may be a major change in perception about the dollar,'' said Dale Durchholz, a market analyst for AgriVisor Services Inc. in Bloomington, Illinois. ``The run-up in commodities prices has been tied to a weakening, and now it appears it may be reaching a bottom.''

  The UBS Bloomberg index has dropped 4.2 percent from a record 1,573.84 on Feb. 29. Before today, the gauge climbed 20 percent this year, while the Standard & Poor's 500 Index declined 4.9 percent and the dollar slid 5.5 percent against a weighted basket of the euro, yen, pound and three other major currencies.

  Futures on the Chicago Board of Trade show an 82 percent chance the Fed will cut the target rate for overnight lending by a quarter-percentage point to 2 percent tomorrow and odds of 71 percent that the rate will be held at that level in June.

  `Take Money Out'

  Fed Chairman Ben S. Bernanke is persuading investors that the financial markets are working again, some analysts said.

  The S&P 500 Index has rallied since the central bank backed the purchase of Bear Stearns Cos. on March 16. Companies sold $45.3 billion of debt last week, the most ever. High-yield bonds are poised for their best month in five years, and mortgage securities are outperforming Treasuries for the first time in 2008.

  ``Commodities have been the darlings of the investment space recently,'' said Eric Wittenauer, an energy and metals analyst at Wachovia Securities in St. Louis. ``Some investors may be looking at these developments as a sign to take money out of commodity markets.''

  Oil, gold, copper and tin have climbed to records this year as demand outpaced supplies. Rice, corn, soybean and wheat prices have also jumped to records, partly because of adverse weather and soaring consumption in Asia. Suring food costs have sparked protests and riots in countries including Haiti, Indonesia, Mexico and Egypt.

  `Fundamental Imbalance'

  ``The rising dollar won't change the fundamental imbalances driving commodity prices, but it may slow the climb as commodities traded in dollars become more expensive internationally,'' Matt Sena, co-manager of New York-based Castlestone Management LLC's Aliquot Commodity Fund, which oversees $900 billion in assets, said in an e-mail.

  Crude-oil futures for June delivery dropped $3.14, or 2.6 percent, to $115.61 a barrel the New York Mercantile Exchange. Yesterday, the price surged to a record $119.93. Natural gas tumbled 3.9 percent, and gasoline declined 3 percent.

  Wheat futures for July delivery fell 32.5 cents, or 3.9 percent, to $8.085 a bushel on the Chicago Board of Trade. Earlier, the price touched $8.0175, the lowest for a most-active contract since Nov. 21. Corn and soybeans also dropped.

  Silver futures for July delivery declined 48.3 cents, or 2.8 percent, to $16.64 an ounce on the Comex division of the Nymex. Gold, which often moves in the opposite direction of the dollar, fell 2 percent to $876.80.

Underlying Risks to China (and its Trading Partners) Still Growing

We've been arguing that (1) the Developing Markets' "inflation beast keeps growling" (click and scroll down) due to structural problems such as oil prices and governments' trade and regulatory policies, (2) Chinese equities' still have an adverse risk/reward ratio, and that (3) we probably won't go overweight equities until we see contagion from the U.S. & European financial crisis result in real crisis in some of the Developing Markets (noted throughout this section).

A post from Michael Pettis in "China Financial Markets" supports our overall caution quite strongly. He continues to see the Chinese yuan on a freight train higher (which will increasingly destabilize global inflation, trade, and demand trends) -- and he sees decreasing chances of anyone stopping it. The consequence of a painful revaluation of the yuan would be another major "leg" to the global financial/economic contagion:

• Speaking about exports, I am increasingly concerned that the trade surplus in China is actually beginning to decline, and much faster than people think. My reasoning is simple and completely intuitive – i.e. there is not a shred of hard evidence to back it up – but I nonetheless think it highly plausible. I contributed the following (somewhat edited) comment to today’s discussion on Chinese reserves on Brad Setser’s blog (http://www.rgemonitor.com/blog/setser):
  

• “Given the rapid increase in various proxies for hot money inflow, it is probably pretty safe to assume that hot money disguised as FDI [foreign direct investment] and/or trade is also growing quickly. Certainly the nearly 70% growth in FDI during the first quarter suggests that there has been an increase in speculative inflows disguised as FDI. After all there was no very good fundamental reason for this growth – in fact it is not hard to argue that FDI in China is less, not more attractive today than in the past few years. If this is true and a big chunk of FDI is simply hot money, it is probably also plausible to argue that hot money disguised as trade has also increased significantly.”
  

• “From that it follows that export growth and the trade surplus have probably declined much faster than the small decline in headline numbers suggest. If true, this complicates matters. Thanks to deteriorating global conditions China may actually already be running a narrow trade surplus or even a small trade deficit, which could make the authorities all the more afraid of a maxi-revaluation [a deliberate, sharp strengthening of the Chinese currency, to ward of speculation/"hot money" that it will continue to rise], and yet for the reasons we have been discussing over the past fifteen months the maxi-revaluation is probably inevitable because of the crazy monetary consequences of hot money inflow. The cost of a maxi-revaluation may be rising even as the cost of steady appreciation is. The longer they wait the worse the options become.”
  

• In other words, if we are starting to see Chinese monetary growth powered exclusively by hot money inflows, instead of by the trade surplus as it was in the past, we are entering into a far more volatile stage of the game, where the consequence of a policy misjudgment may be higher than it has been in the past because the outcome is likely to be much more heavily determined by very volatile and hard-to-control and hard-to-judge hot money flows. The risk associated with an adjustment is rising, in other words, even as the cost of not adjusting is too. I worry that another quarter or two of $200 billion plus increases in reserves is going to make the adjustment process for China much more difficult. It is increasingly important that the recession in Europe and the US be as brief as possible if China is going to have room to adjust. If we see additional weakness in the global environment, I think China’s room for maneuvering declines substantially.
  
  

China Equities -49% From Peak, But Still Adverse Risk/Reward

We continue to wait for the financial crisis to hit some of the Developing Markets before we'll be more comfortable fully rebalancing our somewhat underweight equity allocations. We see a crisis-of-confidence in some Developing Markets as just one of the signposts that it's safer to raise weightings significantly, but an important signpost.

We see China as the bellweather for our call, and we still see the risks somewhat outweighing reward for a 1-2 year time horizon. One the one hand, its economic dynamism continues in many regards, and its equity market has gotten a lot cheaper, nearly cut in half since its peak, and with P/Es in the low-20s for example. On the other hand, we worry about the effects of China's artificially weak currency, its inflation problem, its opaque financial statements, its immature banking system, its real estate bubble, and so on.

An insightful post by professor Michael Pettis at Peking University adds to our view that the economic slowdown that is spreading around the world could treat the Developing Markets more harshly than is generally believed. First, he details the spike in "hot money" flows to China, which will make it more difficult for China to keep its currency weak and its export machine well lubricated.

Second, Pettis describes why he thinks Chinese companies' financial conditions have deteriorated, perhaps more than the much-reduced equity markets discount. It gets to the heart of our reason for slowly raising our Developing Market weightings specifically, and equity weightings generally, following the selloff since the peak in '07:

• In [the 4/19 edition of the South China Morning Post, reporter Shirley Yam] wonders about the much-repeated claim among many of the mainland’s larger firms that “profits and profit margins have dropped because of raw material and fuel cost increases.”

  Displaying a journalist’s cynicism she decides to look at a number of companies to check to see if their margin declines have really been caused by commodity price increases or other factors over which managers have no control. “Is this the sole reason, or just a convenient excuse for inefficient management to pass the buck?” she asks. As she explains in her article,

  This is an increasingly relevant question given the global business environment has turned from deflationary to inflationary where raising costs is the norm. I read through the 2007 annual reports of 10 major state-owned enterprises. The results were disappointing.

  It turns out that the companies she examines have all seen distribution expenses, administrative costs and staff expenses shoot up much faster than revenues – two to eight times as fast. Rather than enjoy economies of scale they seem to be suffering massive diseconomies of scale.

  This kind of thing worries me not because I care about the how managers choose to spend and/or waste money. It worries me because boom times like the one we have enjoyed in China since 2003 often lead to rigidities and excesses in corporate activity and balance sheets that make it very difficult for them to survive sharp turndowns, and this is precisely one very common such type of rigidity.

  Corporate costs can grow much more rapidly than revenues while still allowing the company to show significant increases in net profits as long as revenues are surging, as they have been for Chinese companies in recent years. In case however of a slowdown and a decline in revenues, or at least a sharp reduction in revenue growth, it can take a long time for management to get rising costs under control. The result can be a collapse in cashflow, profitability, and perhaps creditworthiness.

  This is likely both to increase the risk of a sharp, adverse financial adjustment (as companies ability to withstand a downturn is seriously weakened) and to increase the adjustment cost if such a downturn takes place (deteriorating creditworthiness immediately increases financial distress costs and causes corporates to engage in systemically adverse behavior).

  Readers of my blog might easily accuse me of always focusing on the worst case scenario and always looking for problems. Perhaps that is because as a former bond trader I tend naturally to pessimism – after all bond prices tend to have limited upside and nearly unlimited downside, so it pays to worry about the downside more than the upside. But as someone who has experienced too many financial crises and who has written extensively about the history of capital flows and financial crises, I am also pretty sure that when things go wrong nearly everything goes wrong at the same time. This is not a coincidence. It is simply the way unstable balance sheets work, and during boom times companies tend systematically to build risky balance sheets – by, among other things, letting costs get out of control.

Another Stake In the Heart of "Peak Oil" Deniers

If last week's confession by a Lukoil official that Russian oil production has peaked weren't enough to convert "peak oil" deniers, today's comments by Saudia Arabia ought to do the trick. (See the WSJ article here.) As a result, energy prices should continue their steady march upward at a much faster clip than other asset classes (at least until the oil "supply shock" hurts demand enough, which we think will happen later in '08).

So, strictly speaking, our market-weight energy position since starting this blog will remain a drag on relative performance, unless it becomes clear that oil demand is slowing down much more sharply than oil supply. That probably won't happen in the next couple of months, at the rate nations are pursuing inflationary and energy-inefficient policies around the world, and given the rising cost of extracting an incremental barrel of oil.

That said, we haven't raised our energy weighting. We're seeking to "mimic" the performance of rising energy assets with assets that instead improve resource efficiency, reduce industry's carbon & pollution footprints, and create a more sustainable world. To that end, we've written about investments along several major themes, such as agri-biotech, solar power & some other alternative energy platforms, water infrastructure & irrigation technology, green electronics, and others (scroll through our Environment subject for detail).

In addition to "mimic-ing" the performance of rising energy assets, we think these investments could decline less than the energy sector if the global economy slows down enough to drag the energy sector down, because the major environmental investment theme should remain intact.

But we have a lot more work to do before making up for being market-weight energy, rather than overweight, because traditional energy can get more expensive, and still be cheaper than alternative energies. So we're extending our environmental investment themes to include another industrial efficiency play (FLIR Systems - FLIR), and several high barrier-to-entry environmental collection and processing networks (including Clean Harbors - CLHB, and Darling International - DAR). Note that Darling, which collects and processes animal bi-products from thousands of sources, sells into many product categories as a replacement of fossil fuels, and enjoys rising average prices as a result.

Why We're Still Underweight Equities (Just Less-So) - II

We've read a few too many times in the past two weeks that equity markets can, even should, rise sharply in the middle of recessions. And we keep reading that a second-half '08 economic recovery may be back on the table after all.

If this sentiment is becoming too common, recently-bid-up equity markets are becoming more vulnerable to the rash of further economic slowdown headlines that are coming in the next couple of quarters. (That is why most of our efforts to narrow our equity-underweight in recent weeks have been focused on major secular trends with less economic sensitivity.)

Pending bad news often seems well-understood and discounted .... until it arrives and stares investors in the face. And arrive it will. Every day that the credit market remains tight -- and tightens in many parts of the world -- means there's less new investment going into the economic pipeline, and less economic activity in the future. The massive credit unwind in the past six months is stealing significant economic growth from the future, and the credit unwind is still occurring in a pronounced way. (Again, that's why we're sticking with areas of the economy that are grabbing a rising share of investment, such as agriculture, water, and energy efficiency.)

It may be true that there's less chance of an financial collapse now than perceived just a few weeks ago, and that the reduced "tail risk" has helped lift markets in recent weeks. But if (we think when) world economies slow more substantially later in '08, investors will become more fearful of equities. We're waiting for that "second wave" of equity market fear to significantly raise our equity weighting.

A brief FT article tonight adds a few more specifics our concerns about another wave of economic slowdown news hitting market sentiment soon:

• Treasury sell-off hits housing recovery hopes

  The Fed sees the rise in yields as signalling increased market confidence in US economic prospects.

  However, mortgage rates also moved higher, making it more expensive to buy homes and less likely that existing homeowners will be able to refinance mortgages. [Recall, perceiving "the beginning of the end" of the housing crisis has been seen as a necessary condition to end the financial crisis.]
  

  Rates on 30-year fixed-rate mortgages rose to 5.87 per cent from 5.63 per cent a week ago, Bankrate.com said. Jumbo mortgages, those of more than $417,000, rose to 7.19 per cent from 7.06 per cent.

  “The back-up in yields is a concern as it will damage the economic outlook,” said Jane Caron, strategist at Dwight Asset Management.

  The three-month London interbank offered rate – Libor [to which trillions of dollars of loan costs are tied]– increased to 2.91 per cent from 2.71 per cent this week, indicating underlying stress in the financial system.

  Stocks rallied, said Anthony Conroy, head of equity trading at BNYConvergEx, because “the equity market is focused on a second-half recovery...and is not paying attention to the rise in bond yields yet.

Adding Equity Exposure While "Muddling Through" Crisis

Each day that brings a bit more reassurance that the financial crisis won't turn into a catastrophic melt-down represents a good day for markets, after investors fear the worst for much of 2008.

So, even though we're arguing for being underweight equities until one's semi-annual asset allocation rebalance, we've posted about adding equity exposure gradually, and to gain exposure to major investment themes that should combat the economic cycle and provide high beta if markets turn bullish.

During the week of March 31-April 4, we highlighted the Agriculture theme [specifically agri-biotech Monsanto (MON) and Syngenta (SYT)], the length of the Africa & Middle East theme (TRAMX), and the value of adding some U.S. index exposure (VTI). We also were tracking Water, Solar, Genomics, China, Brazil, Canada and other areas.

This week we extended many of those themes, and are also highlighting Suez (SZEZY - a global utility and water infrastructure company), Lindsay (LNN - a high-tech irrigation equipment company), Itron (ITRI - a global utility metering equipment company), and Origin AgriTech (SEED - a Chinese seed company with substantial "option value"). This week we also saw decreased risk in adding exposure to European (VGK), Emerging Markets (VWO), and Brazil specifically (EWZ).

Allocation and the U.S.-Iraq War

The Achilles heel of U.S. investment prospects isn't its credit debacle but its war in Iraq.

The war's costs are driving the dollar lower (and import inflation higher, including oil), crowding out productive investment, sending interest payments and corporate ownership stakes (and the related technology and dividends) abroad, and driving future tax rates much higher.

These are some of the reasons why we've been underweight U.S. equities for most of the past five years -- though not underweight enough -- and why we'd remain beneath the commonly-prescribed 40%+ weightings for U.S. equities. No other nation in the world bears anything approaching the staggering and wasteful losses that the U.S. will continue to bear until the war ends, and well beyond.

Thus our latest post on the war argued that Bush's latest "defining moment" for the Iraq war was also a defining moment for America. Yet recent fighting hasn't improved matters.

A new book by Nobel prizewinning economist Joseph Stiglitz and Harvard's Linda Bilmes argue that the total costs of the war will be $3 trillion, narrowly speaking in terms of direct costs to the U.S. This includes $845 billion in Congressional appropriations thus far (including the $200b '08 supplemental). What's more, Stiglitz and Bilmes write in The Guardian:

• We are not looking at McCain's 100-year scenario - we assume that we are there, in diminished strength, only through to 2017. But neither are we looking at a scenario that sees our troops pulled out within six months. With operational spending going on at $12 billion a month, and with every year costing more than the last, it is easy to come to a total operational cost that is double the $600 billon already spent.

  Second, we include war expenditures hidden elsewhere in the budget, and budgetary expenditures that we would have to incur in the future even if we left tomorrow. Most important of these are future costs of caring for the 40% of returning veterans that are likely to suffer from disabilities (in excess of $600 billion; second world war veterans' costs didn't peak until 1993), and restoring the military to its prewar strength. If you include interest, and interest on the interest - with all of the war debt financed - the budgetary costs quickly mount.

  Finally, our $3 trillion dollars estimate also includes costs to the economy that go beyond the budget, for instance the cost of caring for the huge number of returning disabled veterans that go beyond the costs borne by the federal government - in one out of five families with a serious disability, someone has to give up a job. The macro-economic costs are even larger. Almost every expert we have talked to agrees that the war has had something to do with the rise in the price of oil; it was not just an accident that oil prices began to soar at the same time as the war began.

  We have been criticised, but for being excessively conservative, for including only $5 to $10 of the $75 to $85 increase in the price of oil since then....

Their article continues:

• With the exception of a few lonely surviving supply-siders, most economists believe that deficits matter, and the huge deficits to finance the war will have their toll in the long run. Deficits matter in both the short run and the long. They help crowd out private investment that would have stimulated the economy far more than the war expenditures; and the reduced investments reduce long-run productivity. With 40% of the funds borrowed from abroad, Americans will be sending interest payments abroad - lowering living standards at home. Finally, even Fed Chair Bernanke (formerly the president's economic adviser) admits that the deficits have reduced the room to manoeuvre - the ability of the government to respond to the looming economic crisis.

  Spending so much on the war has economic consequences, even if you don't think there is any connection between the war and the economy's current woes.

  In adding up the quantifiable costs of the war, it is hard not to come up with a number in excess of $3 trillion. In putting a $3 trillion price tag on the war, we believe we have been excessively conservative - a $4 or $5 trillion tag would be more reasonable. And remember - this is just the cost for America.

The Stiglitz/Bilmes estimate does not seem to count the costs to America of having its leaders so mired in war that it impairs its ability to negotiate in its national interest in many other spheres, while other nations such as China intensively procure access to natural resources, build precious reserves, create new alliances and trade agreements, and so on. Nor can Stiglitz/Bilmes or anyone estimate the cost of millions of Islamic adherents' increased antipathy toward the U.S., the increased potential for anti-American terror acts for generations into the future. (America's increased fear of that potential that has also led it to slowly close its borders to thousands and thousands of extraordinarily talented foreign workers seeking H1-B visas.)

As we wrote in our post "A Defining Moment for Iraq" Is a Renewed Risk for America (and for Financial Markets):

• Failing to help stabilize Iraq now, only months before the troop increase was to be tapered off, could significantly prolong the costs to the U.S. and Iraq, or present a new set of even less-appealing options, such as partitioning Iraq into militarily "self-governed" entities, which could cause a new wave of misery.

Still Muddling Though Crisis, But Not Far Enough to Buy Aggressively

The dollar dodged more bullets today, which diminishes slightly the "tail risk" of a financial system collapse, at least for the moment. That's the underlying reason why equity markets rallied, despite the further spike in oil prices and the higher-than-expected U.S. inflation data. "Muddling through" the credit crisis represents the "bull case." We don't think we've muddled through enough to glimpse the light at the end of the tunnel, so we still aren't significantly raising our underweight equity stance ahead of our mid-year rebalance date. Instead, we've only added some high-quality and some relatively counter-cyclical equity exposure.

How did the dollar pull it off today? The Treasury's data on foreign purchases of U.S. assets in February showed foreigners aren't pulling the plug. The Fed's Empire State manufacturing index wasn't worse than expected, and earnings reports weren't bad today. Supporting the dollar relative to the euro, specifically, was the very weak German economic expenditures index. UK economic data was very weak. The continuing food price spiral and increased political instability in Developing Economies is also helping the dollar avoid a rout (see the latest here on food, and note the relenting opposition to genetically modified crops, a trend that continues to aid Monsanto, Syngenta and others).

To describe the market's somewhat surprising rally today a bit more boldly: equities acted as if a few more market participants believe the credit crisis won't deepen significantly, and will ultimately come to good by dampening demand and inflation, creating a "soft landing," and setting up for another long bull-run. This hopeful school of thought is represented by a column here. We'd like to believe it, because there are a few bright lights even as banks strangle their lending operations. After all, non-bank corporations have low inventories and are flush with cash -- the WSJ reports tonight that Microsoft is aggressively extending vendor financing to small business customers. But even Microsoft notes that the bad credit of its customers is "approaching materiality."

The longer the credit markets remain stressed (note that interbank spreads remain very wide), the further food and oil prices rise (increasingly from supply-shock, no less), the longer the U.S. (and increasingly foreign) housing slumps continue unabated, the more we'll see the conditioned bullishness of equity investors be challenged. The next leg down won't be fun. Not before we see fractures in some major Developing Economies will we be likely to declare "the beginning of the end" of the crisis.

Contagion Spreading (and seeds of a US dollar base?)

We have written many times (such as here, here and other posts) that the financial crisis will be landing hard in various Developing Markets, and that inflation (food, fuel, etc) and could be the catalyst in the further "great unwind" of global pressures that have been building this decade.

Our main point in the posts was to say why we remain underweight equities, and that the coming global market selloffs would ultimately take us closer to "the beginning of the end" of the global financial crisis, and subsequently a better time to buy equities -- both globally and in the U.S.

Now, signs are clearer than ever that circumstances are creating the conditions for financial crisis in some developing markets. Acute food inflation, subsequent export barriers that are making matters, worse, food rioting in a half-dozen countries, and increased political risk (for example, note India's nervousness at the Maoist election victories in Nepal) are raising matters to a head. This comes on the heels of years of currency manipulation and hypercredit in certain countries, the slowing pace of trade & financial reform, and of course the continuing U.S. credit bubble implosion.

A Bloomberg update today contains implications that we're closer to cusp of true contagion into Developing Markets. The news may signify only the early stages of a continuing destabilization to the post-2000 trends:

• Rupia Weakens With Peso as Rice Jump Spurs Inflation (Bloomberg, April 14) At the end of last year, rice was selling at $13.865 per 100 pounds, the Philippine central bank had met its inflation target for the first time since 2003 and the peso was the world's second best-performing currency.

  By April 1, rice was surging toward a record $21.60, the inflation rate had almost doubled, and the peso suffered its biggest monthly decline in seven years.

  Record prices for rice, wheat, milk and cooking oil are wreaking havoc with currencies in Southeast Asia, causing a slump in the peso and Indonesia's rupiah. Investors from Deutsche Asset Management to Fortis Investments are dumping their bondholdings on concern inflation will erode returns, putting further pressure on exchange rates. The region has come to depend on strong currencies to contain the rising cost of food and fuel imports.

  ``You can't just rely on currencies to fight inflation, as there comes a time when they have no potential to appreciate further,'' said Nicolas Schlotthauer, a money manager who helps oversee $5 billion at Deutsche Asset Management, part of Germany's largest bank, in Frankfurt. ``Everyone is so complacent about the fact that if there's inflationary pressure, they will let their currencies appreciate. No one thought of potential currency weakness.''

  Currency Reversal

  The Philippine peso tumbled 3.2 percent in March, the most since June 2001. It fell 0.4 percent to 41.750 by the close of trading in Manila, according to data from the Bankers Association of the Philippines. That's a reversal for a currency that gained 9 percent in the fourth quarter, second only to the Armenian dram. In Indonesia, the central bank probably bought more than $2 billion of rupiah, limiting its decline since March 1 to 1.1 percent, according to Oversea-Chinese Banking Corp., Singapore's third-biggest bank. The rupiah slid 0.3 percent to 9,200 per dollar in Jakarta by 5:30 p.m. local time.

  International investors cut their holdings of Indonesian government bonds 3.2 percent in March to 80.7 trillion rupiah ($8.8 billion), according to finance ministry data. Foreign funds sold a net $154 million of stocks in the Philippines this year, helping drive the Philippine Stock Exchange Index down 19.5 percent.

  Deutsche Asset sold all its rupiah debt earlier this year and didn't buy peso bonds because of inflation, Schlotthauer said. Fortis Investments, a unit of Belgium's biggest financial group, expects the rupiah will weaken 3.2 percent to 9,500 per dollar within three months. The firm is ``short'' the rupiah, meaning it is betting the currency will depreciate.

  `Bearish on Indonesia'

  ``I'm really bearish on Indonesia,'' said Didier Lambert, a London-based money manager who helps oversee $4 billion in emerging-market debt at Fortis. ``You will see investor outflows that should weaken the currency.''

  The last time Indonesia's rupiah depreciated due to rising commodity costs was in August 2005, when a jump in global oil prices increased the cost of a state fuel-subsidy program. The rupiah slumped to a four-year low of 10,875.

  ``Subsidies can be very disruptive and expensive for a government to maintain,'' billionaire investor George Soros said in a teleconference from Washington on April 9. Rising food prices may cause ``social and political disruptions,'' he said.

  Emergency Meeting

  The Philippines is urging China, Japan, India and other Asian nations to convene an emergency meeting this month or next on the region's food crisis, Agriculture Secretary Arthur Yap said today. International Monetary Fund Managing Director Dominique Strauss-Kahn said April 12 that ``hundreds of thousands'' worldwide may starve as food costs jump.

  Philippine President Gloria Arroyo said on April 1 she may abandon plans to balance the budget. Two days later, Indonesia widened its 2008 deficit target to 2.1 percent of gross domestic product from an earlier 1.7 percent.

  Food accounts for 49 percent of the consumer price index in the Philippines, the world's biggest importer of rice, and 38 percent in Indonesia, according to Mirza Baig, an economist at Deutsche Bank AG in Singapore. In the U.S., it's 14 percent.

  Indonesian inflation surged to an 18-month high of 8.2 percent in March, breaching Bank Indonesia's target of 6.5 percent. It reached a 20-month high of 6.4 percent in the Philippines, above Bangko Sentral ng Pilipinas's 5 percent target.

  Asian central banks may be able to curb inflation by raising interest rates and seeking stronger currencies because of ``robust'' growth, the Washington-based IMF said on April 9. Excluding Japan, Asia will grow 7.5 percent in 2008, compared with 9.1 percent in 2007.

When Are "Food Export Barriers" Simply "Protectionism"?

Despite the cracks in Alan Greenspan's reputation because of the credit bust and regulatory negligence he fostered, it's worth focusing instead on his repeated warnings against erecting barriers to trade. He frequently stated that a resurgence in trade barriers was the one poison he feared most. Today he reiterated those sentiments to the Senate Finance Committee, and how destructive it would be reverse the wealth-generating tide of the past two decades of trade liberalization.

If the rapid spike in food export barriers (part of what's been happening in the past couple of weeks) creates an even larger contagion of protectionism, ill-feelings, and tit-for-tat among nations than it already has, global economic prospects will quickly darken and become more volatile. This article on Asia Business Newswire today points how quickly the risk of protectionism is rising.

(It is also a reminder of how owning the food commodities and commodity-linked securities may become an even more important element in an optimal diversified portfolio.)

• Sydney, Apr 4, 2008 (ABN Newswire) - Across the developing and emerging economies of the world, and in some developed economies for that matter, governments are opting to shoulder some of the burden of higher food prices or try and control their immediate direction.
  
  The efforts are likely to be fruitless and very expensive for the countries involved, consumers and taxpayers.
  
  From India to Egypt governments are slashing import tariffs on foodstuffs and curbing exports, as well as boosting subsidies: all to try and ease the impact of what will be the big story of 2008 and 2009 - the soaring cost of food.
  
  As we reported this week, an exploding price for rice is the latest cause of much government action.
  
  Egypt, India, the Philippines, Vietnam, Indonesia, Cambodia, parts of Africa, Mexico, Italy, China, Russia, Argentina: the list is growing by the day of governments who now see the rising cost of food and all the social and political problems that brings, as far more important that good governance, low debt, the US recession, subprime debt or American foreign and economic policy.
  
  Even in the developed world the impact is startling. Biofuels in Asia, Europe and the US are withering because of rising costs for corn, canola and palm oil. Food riots have happened in Mexico over the cost of tortilla flour. Italians have protested about the sharp rise in the cost of flour for pasta and bread.
  
  Farmers are being blamed in some countries, such as Argentina and parts of Europe; in the US it's causing an explosion in land values and incomes in parts of the country that have been slowly withering away.
  
  The irony won't be lost on Americans that in the midst of a recession farmers and some of the biggest companies in the US (think Cargill and Archer Midland) will be booming, some with record incomes, and much of it (like Europe) subsidised.
  
  Longer term, however, the side-effects of this largesse will be ugly. Forgoing revenues and paying subsidies hurts national budgets.
  
  India, for example, spent $US600 million on rice and wheat subsidies in 2004-05. Given the surge in rice, maize and wheat prices since then, the cost could be up by a third to a half: something approaching $US1 billion, which a country like India can ill afford, even in the midst of its boom (which is slowing anyway).
  
  In the Philippines, the rice subsidy could top the half a billion dollar mark this year, according to the Asian Development Bank, and the country is scouring Asia and the US for around 1.5 million tonnes of rice at subsidised prices because its stocks have run down.
  
  Indonesia which is thinking of banning some rice exports, like China, India, Vietnam and Egypt, may have to pay $US2.2 billion in food subsidies this year, or around 3% of spending by the national government.
  
  That's three times earlier estimates.
  
  Nearby Malaysia is looking to boost rice imports and hitting a wall because the Philippines has been mopping up as much grain as it can get.
  
  Indonesia and many other countries in Asia also subsidise energy costs and they have skyrocketed with the rise in oil prices over the past three years.
  
  Indonesia is thinking of cutting rice exports, even though it will have a surplus this year of around two million tonnes (it imported just over 1 million tonnes in 2007).
  
  Soaring food and fuel prices are driving global inflation. Consumer prices in China hit an annual rate of 8.7% in February, an 11-year high, and reached a 13-month peak in India of 6.8%.
  
  World prices for rice, wheat, soybeans and corn have all increased sharply: rice and wheat prices have doubled in the year - rice is up 30% or more in a week....
  
  The World Bank said this week it considered soaring food and fuel prices as greater challenges to East Asian governments than the financial turmoil in the United States and slowing global growth.
  
  As we said yesterday, it's a similar outlook from the Asian Development Bank.
  
  "The major risk lies not so much in softer growth but in rising commodity prices and accelerating inflation,'' the Bank said yesterday. "Appropriate macroeconomic responses to accelerating inflation are likely to include tighter monetary policy and some exchange-rate appreciation.''
  
  "Indeed, published inflation rates disguise the true extent of underlying inflation pressures due to the presence of subsidies, administrative price controls and cuts in excise taxes," it said.
  
  The subsidies used by many governments in the region to cushion the impact of soaring fuel and food prices are posing a threat to budgets and the bank said that cash handouts to the poor may be a better and cheaper option.
  
  "If governments do not rethink these expensive and inefficient subsidy programs, fiscal costs could escalate sharply and require painful adjustments (or accelerating inflation, or both) later," the ADB said.
  
  "Carefully targetted direct income support for the poor, within strict budgetary limits, might better alleviate stresses, and at much lower cost."
  
  Saudi Arabia has cut import taxes across a range of food products this week, slashing its wheat tariff from 25% to zero and reducing tariffs on poultry, dairy produce and vegetable oils.
  
  On Monday, India scrapped tariffs on edible oil and maize and banned exports of all rice except the high-value basmati variety, while Vietnam, the world's third biggest rice exporter, said it would cut rice exports by 11%.
  
  In Argentina, farmers called off a protest against attempts by the government of President Cristina Fernández to redistribute the benefits of rising commodity prices by increasing export taxes on soybeans and other crops.....
  
  

Why We're Still Underweight Equities (Just Less-So)

The stock market doesn't process recessions with "V" bottoms. The market's reactions come in waves.

We think there's another wave of bad news coming to credit markets and the economy.

We have many concerns, and we're waiting for other shoes to drop, as we discuss in previous posts. Developing Economy inflation is a big concern of ours, for example.

This Bloomberg article is typical of the kind of fears we have:

• Banks are so overwhelmed by the U.S. housing crisis they've started to look the other way when homeowners stop paying their mortgages.
  
• The number of borrowers at least 90 days late on their home loans rose to 3.6% at the end of December, the highest in at least five years, according to the Mortgage Bankers Association in Washington. The figure, for the first time, is almost double the 2% who have been foreclosed on.
• Lenders who allow owners to stay in their homes are distorting the record foreclosure rate and delaying the worst of the housing decline, said Mark Zandi, chief economist at Moody's Economy.com, a unit of New York-based Moody's Corp. These borrowers will eventually push the number of delinquencies even higher and send more homes onto an already glutted market.
• "We don't have a sense of the magnitude of what's really going on because the whole process is being delayed,'' Zandi said in an interview. ``Looking at the data, we see the problems, but they are probably measurably greater than we think.''

Developing Markets' Inflation Beast Keeps Growling

Today the Asian Development Bank (ADB) contributed to our explanation (expressed here and in previous posts) of why rising inflation in Developing Markets keeps us underweight there, and mired in the middle, not at the end, of global financial crisis. The DevelopING Markets don't yet have a track record of engineering soft landings, and a combination of their inflation, the U.S./Europe economic slowdown, and credit crisis make the maturing markets quite vulnerable to financial crises of their own. Such crises, would signal a better time to raise allocations to the Developing Markets.

According to the FT today:

• Ifzal Ali, ADB's chief economist, warned that the inflationary threat was much greater than official figures suggested in countries such as India that damp the price impact via subsidies.
  

Our previous posts (such as this link) also explain why Developing Nations' subsidies and other forms of micro-management of inflation only make matters worse -- because they inhibit the natural function of higher prices from dampening demand, and because the underlying inflationary causes of easy credit and artificially weak currencies go un-addressed.

The FT continues:

• [Ali said], "South Asia is going to be very vulnerable to high commodity prices," Mr Ali said. "What is happening because of [price] controls is that the inflationary pressures are grossly under the table. But the pressures are there and building."

And switching to Asia:

• In China, where inflation has accelerated to its fastest pace in 11 years, "the challenge is now to bring down inflation and at the same time avoid a hard landing", according to Mr. Ali
• In the case of countries such as Vietnam, where the inflation rate is expected to double this year to about 18%, the ADB said the government needed urgently to introduce a blend of monetary and fiscal tightening. It also needed to allow some currency appreciation, in order to prevent its stellar recent economic progress from grinding to a halt.
• Several Asian governments are likely to be forced into monetary tightening soon, says the ADB, including India where inflation could turn into a serious political issue in the run-up to elections next year.

And in a nod to the biggest fear -- a wage & price spiral that becomes very painful to break, once it gets started, the FT article continues:

• While inflation has been fueled by soaring world food and energy prices, the ADB also stressed on Wednesday that the problem was in equal part generated by domestic factors, such as skills shortages amid an economic boom.
  

If Developing Markets do show signs of "muddling through" the crisis period by getting a handle on inflation (via a healthy combination of gradual currency appreciation, financial reforms, and slower demand from U.S. and European trading partners, etc), we'll raise our Developing Market underweights. In the meantime, we're too nervous about potential crises in these new markets to raise allocations now.

Moving Further into the "Middle" Stages of the Crisis

We've discussed some of the indications we're looking for in order to declare "the beginning of the end" of the financial crisis. Signs would include: meaningful commodity price pullback, one or two upper-tier bank defaults, and/or financial crisis in parts of the Developing Economies, for example. These would be important indicators to us that the financial crisis is moving into a later stage, and opportunity to buy higher-risk assets.

We've also written about the other possibility: that we could "muddle through" without another extremely painful stage of crisis.

In the past week, "muddling" has come out ahead.

As a result we've slightly raised our U.S. equity exposure, by about 1% (though we're still underweight our strategic asset allocation target).

A few of the most recent contributors to the "muddling through" picture: Commodity prices have pulled back a bit, governments have become increasingly aggressive in trying to alleviate the problems, Lehman has been able to raise capital and even up-sized the deal from its initial target, Blackstone has raised a $10.9bn in a new fund for real estate, UBS has taken a gigantic writedown but confidence (at least today) is improved enough to send the stock higher, Thornburg Mortgage escaped bankruptcy for now, corporate M&A and new greenfield projects have been announced, the IMF's latest data has indicated no real evidence of major nations diversifying their reserves away from U.S. dollars (and the Middle East made some reassuring sounds), foreign currency reserves keep rising significantly (further increasing hope that they'll serve as a buffer against non-U.S. economic crisis), and Developing Market inflation pressures have caused some market-unfriendly numbers and social unrest but have not yet provoked major crisis with its own contagion effect, and China's economy has shown real evidence of slowing (raising hopes, at least for now, of a "soft landing").

And in general, our readings have crossed seemingly hundreds of examples to support the idea that the pace of global innovation is increasing, perhaps rapidly, as startups and collaborations are attacking needs in every sector, and notably energy, financing, trade, agriculture, and water.

We still think the financial crisis is in its middle stages because some underlying pressures are increasing even while others may be abating. We think that markets will rise and/or fall significantly as these ultimate questions are gradually resolved: (1) whether the massive U.S. and lesser European credit bubbles can deflate without triggering systemic breakdown, (2) now that "the great unwind" of the global currency imbalances have begun, whether Developing Markets can sustain gradual currency appreciation toward fair value without triggering another contagious financial crisis at home or abroad, (3) whether the war in Iraq eases, (4) whether we see a major intensification of a current challenge (food prices, economic nationalism, etc) or an entirely new challenge.

As a result of seeing ourselves is in the "middle stages" of crisis, we aren't planning to re-balance our equity weighting fully ahead of our mid-year rebalance. Only further dislocation, or signs of further "muddling through," will move more of our cash into equities before mid-year.

Developing Markets' Inflation Beast Continues Growling

For two days we've cited anecdotes about how the Developing Economies' micro-mercantilist policies to address inflation aren't working, and won't engineer a soft landing (slower, less-inflationary economic growth rates). There will be financial crises along the path to slowdown, and that's why we're not raising our Developing Markets allocation from our current underweight.

Our post yesterday highlighted India and East Asia's widespread policies of limiting exports of inflationary goods (to retain more supply at home), and reduction of import taxes on those goods to encourage cheaper imports. We view these as potentially offsetting policies that don't address the root causes of inflation, namely the rapid growth in credit, currency manipulation in many Developing nations that artificially juices export growth and high import prices, and other policies. A previous post implicates Brazil, too.

Today, a WSJ article makes the same point about Argentina:

• The recent trouble [social unrest[ began not in Buenos Aires but in the provinces, where agriculture is the main economic activity. Farmers rebelled earlier this month when the government announced an increase in export taxes on agricultural products....
• Take, for example, soy beans. The new export tax will be raised to 44% from 35%. But since farmers also have to pay a 35% income tax on profits, the effective tax rate is significantly higher. "The farmer ends up paying essentially a 63% tax on gross income," says Pablo Guidotti, dean of the school of government at Argentina's DiTella University. If the price of soy goes up, Mr. Guidotti adds, the "retention rate" increases until the government can end up taking as much as 95% of any marginal increase in a farmer's gross income.
• In response to the tax increases, farmers have blocked roads in some 300 locations around the country, pledging not to allow their goods to reach markets. The effects of the action have been felt in the capital, where demonstrators have taken to the streets in sympathy for the farmers and against what they say is government arrogance. The strike is now in its third week.
• [President Cristina] Kirchner says the tax increase is a redistribution mechanism, suggesting that growers and ranchers have to be forced to share more of their good fortune with others. But the greater motivation behind the export-tax increase is inflation.
• This government, it seems, will do just about anything to reduce inflation except the one thing that would solve the problem: Let the peso strengthen. It has imposed price controls on businesses; frozen, and then subsidized, energy prices; and prohibited the export of beef. Last year it fired the director of the government's agency for inflation data because she refused to fudge the numbers. Even so, prices rose by an estimated 20% in 2007 and expectations for this year remain high. This would explain the new round of confiscatory export taxes. By discouraging farmers from sending food abroad, the government thinks it can increase food supplies inside the country and damp prices.

To repeat from our post last night:

This is a big reason why we're not adding to our Developing Markets weighting now, and it's also a reason why we're waiting-out the dollar weakness rather than piling-on the shorts. As instabilities and unsustainable policies within Developing Market economies become more apparent (very very soon), the dollar will give more reassuring signals. Financial seizures within Developing Markets will, we continue to believe, signify "the beginning of the end" of the global financial crisis, and a buying opportunity for equities worldwide.

Developing Markets' Inflation Beast Growling Louder, Even As Their Economies Decelerate

We're not ready to raise our underweight Developing Markets allocation, as we'll only believe the "soft landing" scenario when we see it.

Our post yesterday on Brazil expressed our concern that underlying inflation pressures are only exacerbated by government policies to micro-manage prices rather than slow down the credit and demand boom.

India presents the same concerns. Earlier today, India's inflation reached a 13-month high of 6.7%, exceeding estimates. The following form of micro-management of the economy -- discussed in today's FT report -- would seem to have be neutral to global inflation, which circles back to keep India in the inflationary net:

• The finance ministry is expected to cut import duties on commodities such as steel, while clamping down on exports. Last week it reduced import duty on edible oil and has limited export of non-basmati rice. "Large price increase portends significant government action," said economists at Goldman Sachs. "With inflation driven by high commodity prices, the government has reduced import duties, banned exports and increased minimum export prices of certain food commodities."

Reduce some prices, raise others ... How does that combat inflation?

This form of inflation micro-management seems to be becoming a lot more common across the Developing Markets, as shown by tonight's WSJ article titled "Rice Hoarding Pressures Supplies." While the world would benefit from increased free markets in goods that are in local short-supply, the "rational" reaction pursued by self-interested parties is to hoard. So:

• As prices hit new highs, farmers across Asia are hoarding their crops, raising the prospect of a shortage in Asia and Africa that could lead to widespread unrest.... Governments around the region are curbing exports to safeguard their domestic supply, putting further upward pressure on prices.

The greater the Developing Market inflationary pressures become -- ultimately caused by the rapid growth in credit, currency manipulation and other policies that favor very rapid growth over stable growth -- the harder they'll be to reign in without causing a few major dislocations along the way.

This is a big reason why we're not adding to our Developing Markets weighting now, and it's also a reason why we're waiting-out the dollar weakness rather than piling-on the shorts. As instabilities and unsustainable policies within Developing Market economies become more apparent (very very soon), the dollar will give more reassuring signals. Financial seizures within Developing Markets will, we continue to believe, signify "the beginning of the end" of the global financial crisis, and a buying opportunity for equities worldwide.


Keying-off the rice example used above, we'll reiterate that we think most major ag-related investments will remain less susceptable to the macro gyrations that we see continuing. See our post "Allocation and Agriculture," for instance.

Brazil: Internal Financial "Reform" Deformed?

After its '00s boom, Brazil is not as safe a haven for assets that its market indices show many investors believe.

In our March 25 post we cited a VoxEU article (Foreign Direct Investment, and Domestic Financial Reform: A Marriage Made in Heaven?) that concluded:

• Not only does financial reform matter, it is the most important reform a country can pursue in order to influence the decisions of foreign investors.

The linked article here on RGE Monitor describes how Brazil is making big mistakes in its internal financial management, as the country is facing increasing inflation pressures. Rather than take its medicine by making credit more expensive, it is making piecemeal efforts to band-aid problems, leaving higher risks that inflation pressure will build.

While Brazil's macro picture -- its wealth of water & land (agricultural production capacity), and infrastructure investment growth -- is enormously positive, at some point these positives will be fully factored into the skyrocketing equity prices there, and imbalances perpetuated by internal financial system mismanagement will end the bull market. We think the "at some point" may be nearer at hand than many investor suspect, due to contagion from the current financial crisis.

From RGE Monitor (originally published by Valor Economico), titled Brazil: Back to the Past:

• Different from the policy followed since 1999, which set the exchange rate floating according to the market and executed monetary policy horizontally, using classical tools, like interest rates, the current administration apparently prefer micro managing the system, with constant interventions. An increase in the price of iron ore? The government calls the iron-ore producers, with an implicit threat to impose price controls, instead. The exchange rate is appreciating? There is an increase of import tariffs and export subsidies in the sectors that are 'worthy', and the government issues internal debt to increase international reserves in a useless and expensive arbitrage for the country. Instead of increasing interest rates, they impose a selective control on credit. It is a mirror image of the economic policy from the '70s and '80s, with all the distortions and inefficiencies that led to disaster.

Brazil's year-over-year broad money growth is 16.2% means that a range of micro-management tactics may mask inflationary pressure for a while but probably can't contribute much to restoring balance. Our blog posts have raised similar questions about China; its M2 is growing at a 17.5% rate. The global slowdown that's starting to unfold will ultimately help restore something like a balance, but history tells us not to bet the farm on "soft landings" in emerging markets.

We continue to wait for lower levels in U.S. and non-U.S. equities before rebalancing to our long-term strategic targets.

"A Defining Moment for Iraq" Is a Renewed Risk for America (and for Financial Markets)

We've always viewed the U.S. war in Iraq as the historical moment when the world would plainly see a reversal of America's fortunes relative to other nations. America's trillion-dollar investment that produces zero return on principal -- and potentially nothing but future losses -- is also contributing to the demise of the dollar, greater risk that the Fed and Treasury won't be able to contain the credit crisis, a rising future tax burden, and higher oil prices into perpetuity.

So when George Bush said today that the current wave of fighting in Iraq presents "a defining moment in the history of Iraq," even he knows the situation is dire. And given my view of the Iraq war's significance for America, we must consider the corollary to Bush's statement -- that the wave of fighting is also a defining moment in the history of America.

Failing to help stabilize Iraq now, only months before the troop increase was to be tapered off, could significantly prolong the costs to the U.S. and Iraq, or present a new set of even less-appealing options, such as partitioning Iraq into militarily "self-governed" entities, which could cause a new wave of misery.

Incidentally, either of these scenarios would add pressure to the U.S. financial predicament, and to officials' attempts to head off the financial crisis. This would lend more sway to the bears. For example, to a very bearish NYU economist Nouriel Roubini, that would mean further movement down his "Twelve Steps to Financial Disaster," explained on his RGE Monitor website and here. According to Roubini, another breakdown of a major financial intermediary such as Bear Stearns would be Stop Nine, en-route to Step Ten, a severe downturn in stock markets.

We continue to postpone the rebalancing of our underweight equity allocations.

"China, If You Think the U.S. Real Estate Bust Is Bad..."

There's a big reason why, before rebalancing our underweight equity allocations, we're waiting for financial crisis to hit the Developing Economies. In particular, China's real estate boom could end very badly.

Today a WSJ article provides more fodder for this line of argument, especially because it's attracting so little attention from Developed investment markets, as this link sensibly points out.

Read the WSJ article today titled, "Tables Turn Quickly on Chinese Developers."

From our past readings, we understood that the inflationary roots in China's real estate development story run deep and wide: (1) an enormous amount of Chinese property development was premised on the certainty that values would increase in the future (sound familiar to the U.S. mortgage lending bubble?). We also understood that (2) a major source of financing for China's development boom has been city governments evicting poor residents and giving the land to property developers as partial compensation for developing the land (same as printing money) -- and that China's many large cities have been aggressively competing to add real estate capacity in this way for most of the last decade. We also understand that (3) low-to-negative real interest rates in China have financed a significant portion of China's stock market boom -- consumers have been borrowing to speculate in stocks despite the government's efforts to enforce rules (remember, China is a DevelpING economy), and the too-easy money has surely found its way into the pockets of individual home buyers. We've read that (4) there is almost nothing like a developed market "credit score" for individual Chinese borrowers. Isn't that even worse than the widespread "no-documentation" loans that epitomized the U.S. mortgage boom-bust?

The Chinese government is starting to pull out the stops to rectify these problems (at least they're being more proactive than U.S. financial regulators were during the boom), working desperately to prevent new real estate capacity from coming to market. But it may be too little too late.

From Jonathan Cheng's WSJ article:

• Three months into 2008, China's property developers are under siege. Property prices are showing signs of weakness in many of the country's key markets, and capital markets have all but seized up for these -- and other -- offerings. The Chinese government is on a high-profile campaign to clamp down on new bank loans, hoping to curb inflation, rising at its fastest clip in a decade.
• Companies that leveraged big last year are now strapped for cash, unable to build on the land they have accumulated. Beijing is breathing down their necks, having pledged earlier this year to tax and seize hoarded land.....
• The latest casualty of changed conditions: Guangzhou-based developer Evergrande Real Estate Group, which last week shelved an IPO it hoped would raise as much as $2.2 billion....
• Evergrande's woes illustrate many of the headwinds facing Chinese developers. Despite stock-market turmoil, the developer was so weighted down by debt it had no choice but to take a crack at an IPO. More than half the funds Evergrande was hoping to raise were set aside to pay for plots it accumulated during a furious land grab last year.
• "We are highly leveraged, and a deterioration of our cash-flow position could materially affect our ability to service our indebtedness and to continue our operations," Evergrande wrote in its listing prospectus. With the IPO shelved, the company hasn't said how it will seek funds.
• Even titans have had to trim their ambitions.... Soho China Ltd [co-founder] Pan Shiyi ... told Shanghai Securities News that Chinese developers this year will "find themsevels in extraordinarily difficult financial straits."....
• "The 'model' that worked in 2007 was predicated on prices for apartments growing faster than land costs," says Todd Schumbert, an analyst with Deutsche Bank in Singapore.... Now, with home prices faltering and funding sources scarce, "This game is over."....
• In the past few months, Wang Shi, the head of megadeveloper China Vanke, a Shenzhen-listed company based in that boomtown, surprised the market by slashing prices heavily on new flats and suggested in a recent television interview that people wait three to four years before purchasing a new home.
  

This topic is much bigger than any single article can tell. Back on September 18 '07, I clipped an article by Jamil Anderlini at the Financial Times. A few quotes:

• China Construction Bank, the country's second largest lender, is taking a cautious line on China's economy and is reducing its exposure to an overheating property market, the bank's chairman told the Financial Times.
• [CCB chairman Guo Shuqing said], "The real estate market is more overheated in the coastal areas and the annual price increase is too high." [Oh, only the "coastal areas" of China?]
• Investor interest [in real estate company equity, at the time the article was written] is partly driven by soaring profitability at China's newly reformed banks, but those profits are diverting attention from rising credit risks, according to Standard & Poor's, the rating agency. "The rapid industry-wide expansion of credit exposure suggests many banks prioritise expandi