Global monetary policy

Ben's bind

Disentangling the links between the Fed, the falling dollar and the soaring price of the world's commodities

THE spirit of St Augustine hovered over the Federal Reserve this week. “Oh Lord, let us stop cutting interest rates, but not yet,” is pretty much what America's central bankers decided on April 30th. The Fed's governors cut their policy rate by another quarter-point, to 2%. But the accompanying statement gave a small hint that they may now pause.

There are plenty of reasons to stop cutting. Real interest rates are now firmly negative. Although the housing market continues to contract—the latest figures show sales falling, prices tumbling and the number of vacant homes soaring—the economy is limping rather than slumping. According to initial GDP estimates released on April 30th, output grew at an annualised rate of 0.6% in the first three months of the year—the same pace as in the previous quarter and faster than most people expected. The mix of growth was not good. Final sales fell while firms built up their stocks, which bodes ill for future output. But with tax-rebate cheques arriving in the mail, a dose of fiscal stimulus is imminent.

A growing chorus worries that ever lower policy rates are adding to America's problems. Some prominent economists, including Martin Feldstein of Harvard University and Bill Gross of PIMCO, a big money-management firm, have urged the central bank to stop. Fed cuts, they argue, are doing little to reduce borrowing costs but have sent commodity prices soaring—fuelling inflation and hitting Americans' wallets hard.

Thanks to the credit crunch, Fed loosening plainly packs less punch than hitherto. Lending standards are tightening across the board. The cost of a 30-year mortgage has risen over the past six months, even as short-term rates have tumbled. But monetary policy has not been impotent. One route through which it has worked has been the weaker dollar. Although the greenback has been sliding for over five years, the pace of decline stepped up as the Fed slashed rates. Since August the dollar has fallen by 7% against a broad basket of currencies and 13% against the euro. Together with strong global growth, this weakness has cushioned and reoriented America's economy. Strong foreign earnings have boosted corporate profits. Strong exports have countered the weakness in construction. Exclude oil, and America's current-account deficit has shrunk to an eight-year low of 2.4% of GDP.

But oil—and other commodities—are the crux of the problem. In the past, economic weakness in America has usually pushed the price of oil and other commodities down. That relationship has weakened thanks to demand growth in big commodity-intensive emerging economies. But the recent surprise is that commodity prices have soared even as America's economy has stalled and forecasts for global growth have been trimmed as well. No one expects global growth to accelerate this year, yet the price of crude oil is up 20% since the beginning of the year, The Economist's overall commodity-price index is up 18%, the metals index is up 24%, and the food-price index is up 18%. Supply shocks—from drought in Australia to strikes at Nigerian oil wells—are clearly part of the problem. But the fact that prices have soared across so many commodities suggests a common cause.

Could the culprit be the Fed? Advocates of this idea point to two channels. First, by slashing real interest rates, the Fed has encouraged speculation in commodities by reducing the cost of holding inventories. Second, by pushing down the dollar, Fed looseness is pushing up the price of dollar-denominated commodities.

Jeff Frankel, a Harvard economist, has long argued that low real interest rates lead to higher commodity prices. When real rates fall, he points out, commodity producers have more incentive to keep their asset—whether crude oil, gold or grain—in the ground or in a silo, than to sell today. Speculators, in turn, have more incentive to shift into commodities. There is no doubt that commodities have become an increasingly popular investment category—in fact they bear many of the hallmarks of a speculative bubble. But inventories for many commodities, particularly grains, are unusually low.

What about the dollar link? Chakib Khelil, president of the Organisation of Petroleum-Exporting Countries, argued this week that oil could reach $200 a barrel largely because the market was being driven by the dollar's slide. Movements in the euro/dollar exchange rate and the price of oil have become extremely close (see chart). An analysis by Jens Nordvig and Jeffrey Currie of Goldman Sachs shows that the correlation between weekly changes in the oil price and the euro/dollar exchange rate has risen from 1% between 1999 and 2004 to 52% in the past six months.

That link is partly a matter of accounting. If the dollar falls, the dollar price of a commodity must rise for its overall price—in terms of a basket of global currencies—to remain stable. But commodity prices have risen even when priced in non-dollar currencies. And the correlation between changes in the price of oil and the euro/dollar exchange rate has risen even when oil is priced in a basket of currencies, such as the IMF's special drawing rights.

So is the weaker dollar driving oil prices up or are high oil prices driving the dollar down? The Goldman analysts argue the latter. Dearer oil is pushing the dollar down, they claim, because oil exporters import more from Europe than America and hold less of their oil revenues in dollars. A second factor lies with central banks. Because the Fed focuses on “core” inflation (which excludes food and fuel), whereas the ECB targets overall inflation, America's central bank runs a looser policy in response to higher oil prices, thus pushing the dollar down.

Another reason to suspect that the Fed is more than a bit player is that American interest-rate decisions have a disproportionate effect on global monetary conditions. Some emerging economies still peg their currencies to the dollar; many others have been reluctant to let their exchange rates rise enough to make up for the dollar's decline. As a result, monetary conditions in many emerging markets remain too loose. This fuels domestic demand, pushing up pressure on prices, particularly of commodities. All of which suggests that the Fed's decisions are propagated widely through the dollar.

The most recent circumstantial evidence also suggests that the Fed may bear some responsibility for the commodities boom. The dollar slipped after the Fed's rate-cut decision as investors reacted to its doveish tone, though at $1.56 per euro, it was still up 2.6% from its low of $1.60 on April 22nd. The price of oil, after hitting a record high of almost $120 a barrel on April 28th, had tumbled to $113 on April 30th. But the price of crude and other commodities rose afterwards. If those reactions persist, America's central bankers may have to reflect carefully.

INTERNATIONAL BANKING

Paradise lost

Banks are bound to fail from time to time. But, asks Andrew Palmer (interviewed here), does the fallout have to be so painful?

WILSON ERVIN, the chief risk officer at Credit Suisse, a large Swiss bank, cannot pinpoint the precise moment he knew something was up: “This was not like Paul on the road to Damascus.” But signs of the gathering subprime storm in America started to trigger alarms in late 2006. Data from the bank's trading desks and from mortgage servicers showed that conditions in the subprime market were worsening, and the bank decided to cut back on its exposures. At the same time Credit Suisse's proprietary risk model, designed to simulate the effect of crises, signalled a problem with the amount of risk-adjusted capital absorbed by its portfolio of leveraged loans. It duly started hedging its exposure to these assets as well.

Mr Ervin could not have guessed at the sheer scale of what was coming. For nine months now, banks have been in a panic: hoarding cash, nervous of weaknesses in their own balance-sheets and even more nervous of their counterparties. More damaging still, money-market funds have steered clear of banks as well. The drying-up of liquidity not only created havoc in the backrooms of the financial system. It also wrecked the front door, thanks to the dramatic collapse of Bear Stearns, an 85-year-old Wall Street investment bank that was bought for a song by JPMorgan Chase in March. The Federal Reserve offered emergency funding to the investment banks for the first time since the 1930s, and there were bank bail-outs in Britain and Germany too.

The economic effects are set to be just as striking. According to a study of previous crises by Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard, banking blow-outs lop an average of two percentage points off output growth per person. The worst crises reduce growth by five percentage points from their peak, and it takes more than three years for growth to regain pre-crisis levels. With so much at stake if the banks mess up, regulators and politicians are now asking fundamental questions. Should banks be allowed to take on as much debt? Can they be trusted to make their own assessment of the risks they run? Bankers themselves accept the need for change. “We've totally lost our credibility,” says one senior European banker.

To regain trust, banks will not need to be totally bomb-proof. Safe banks are easy enough to create: just push up their capital requirements to 90% of assets, force them to have secured funding for three years or tell them they can invest only in Treasury bonds. But that would severely compromise their ability to provide credit, so a more realistic approach is needed. This special report will ask how banks should be run and regulated so that the next time boom turns to bust the outcome will be less miserable for all concerned.

If the crisis were simply about the creditworthiness of underlying assets, that question would be simpler to answer. The problem has been as much about confidence as about money. Modern financial systems contain a mass of amplifiers that multiply the impact of both losses and gains, creating huge uncertainty.

Standard & Poor's, one of the big credit-rating agencies, has estimated that financial institutions' total write-downs on subprime-asset-backed securities will reach $285 billion, more than $150 billion of which has already been disclosed. Yet less than half that total comes from projected losses on the underlying mortgages. The rest is down to those amplifiers.

One is the use of derivatives to create exposures to assets without actually having to own them. For example, those infamous collateralised debt obligations (CDOs) contained synthetic exposures to subprime-asset-backed securities worth a whopping $75 billion. The value of loans being written does not set a ceiling on the amount of losses they can generate. The boss of one big investment bank says he would like to see much more certainty around the clearing and settlement of credit-default swaps, a market with an insanely large notional value of $62 trillion: “The number of outstanding claims greatly exceeds the number of bonds. It's very murky at the moment.”

A second amplifier is the application of fair-value accounting, which requires many institutions to mark the value of assets to current market prices. That price can overshoot both on the way up and on the way down, particularly when buyers are thin on the ground and sellers are distressed. When downward price movements can themselves trigger the need to unwind investments, further depressing prices, they soon become self-reinforcing.

A third amplifier is counterparty risk, the effect of one institution getting into trouble on those it deals with. The decision by the Fed to offer emergency liquidity to Bear Stearns and to facilitate its acquisition by JPMorgan Chase had less to do with the size of Bear's balance-sheet than with its central role in markets for credit-default and interest-rate swaps.

Trying to model the impact of counterparty risk is horribly challenging, says Stuart Gulliver, head of HSBC's wholesale-banking arm. First-order effects are easier to think through: a ratings downgrade of a “monoline” bond insurer cuts the value of the insurance policy it has written. But what about the second-order effect, the cost of replacing that same policy with another insurer in a spooked market?

The biggest amplifier of all, though, is excessive leverage. According to Koos Timmermans, the chief risk officer at ING, a big Dutch institution, three types of leverage helped propel the boom and have now accentuated the bust. First, many banks and other financial institutions loaded up on debt in order to increase their returns on equity when asset prices were rising (see chart 1). The leverage ratio at Bear Stearns rose from 26.0 in 2005 (meaning that total assets were 26 times the value of shareholders' equity) to 32.8 in 2007.

Second, financial institutions were exposed to product leverage via complex instruments, such as CDOs, which needed only a slight deterioration in the value of underlying assets for losses to escalate rapidly. And third, they overindulged in liquidity leverage, using structured investment vehicles (SIVs) or relying too much on wholesale markets to exploit the difference between borrowing cheap short-term money and investing in higher-yielding long-term assets. The combined effect was that falls in asset values cut deep into equity and triggered margin calls from lenders. The drying-up of liquidity had an immediate impact because debt was being rolled over so frequently.

That is not to suggest that the credit crunch is solely the responsibility of the banks, or that all of them are to blame. Banks come in all shapes and sizes, large and small, conservative and risk-hungry. Alfredo Sáenz, the chief executive of Santander, a Spanish retail giant, recalls attending a round-table of European bank bosses during the good times at which all the executives were asked about their strategic vision. Most of them talked about securitisation and derivatives, but when it was Mr Sáenz's turn, he touted old-fashioned efficiency. He did not get any questions. “There were 'clever' banks and 'stupid' banks,” he says. “We were considered one of the stupid ones.” No longer.

Beyond the banks, a host of other institutions must take some of the blame for the credit crunch. The credit-rating agencies had rose-tinted expectations about default rates for subprime mortgages. The monolines took the ill-fated decision to start insuring structured credit. Unregulated entities issued many of the dodgiest mortgages in America.

And no explanation of the boom can ignore the wall of money, much of it from Asia and oil-producing countries, that was looking for high returns in a world of low interest rates. “It is indisputable that the global glut of liquidity played a role in the 'reach for yield' phenomenon and that this reach for yield led to strong demand for and supply of complex structured products,” says Gerald Corrigan, a partner at Goldman Sachs and an éminence grise of the financial world.

Many blame the central banks: tougher monetary policy would have encouraged investors to steer towards more liquid products. Others blame the investors themselves, many of whom relied on AAA ratings without questioning why they were delivering such high yields.

Wheel-greasers

Still, the banks have been the principal actors in this drama, as victims as well as villains. The S&P 500 financials index has lost more than 20% of its value since August, and many individual institutions have fared far worse. Analysts have been forced to keep ratcheting down their forecasts. “The downside will be longer than anyone expects,” says David Hendler of CreditSights, a research firm. “There is so much leverage to be unwound.”

According to research by Morgan Stanley and Oliver Wyman, investment banks will be more severely affected by this crisis than by any other period of turmoil for at least 20 years. By the end of March the crunch had already wiped out nearly six quarters of the industry's profits, thanks to write-downs and lower revenues. Huw van Steenis of Morgan Stanley reckons that the final toll could be almost two-and-a-half years of lost profits (see chart 2).

Other industries have gone through similarly turbulent times: airlines in the wake of the terrorist attacks on September 11th 2001, technology firms when the dotcom bubble burst. Even within the financial sector the banks are not the only ones currently suffering: hedge funds, insurers, asset managers and private-equity firms have been hit too. But banks are special.

The first reason for that is the inherent fragility of their business model. Bear Stearns, an institution with a long record of surviving crises, was brought to its knees in a matter of days as clients and counterparties withdrew funding. Even the strongest bank cannot survive a severe loss of confidence, because the money it owes can usually be called in more quickly than the money it is owed. HBOS, a big British bank with a healthy funding profile, watched its shares plummet on a single day in March as short-sellers fanned rumours that it was in trouble. It survived, but the confidence trick on which banking depends—persuading depositors and creditors that they can get their money back when they want—was suddenly laid bare.

The second reason why banks are special is that they do lots of business with each other. In most industries the demise of a competitor is welcomed by rival firms. In banking the collapse of one institution sends a ripple of fear through all the others. The sight of customers queuing last September to withdraw their money from Northern Rock, a British bank, sparked fears that other runs would follow.

The third and most important reason is the role that banks play as the wheel-greasers of the economy, allocating and underwriting flows of credit to allow capital to be used as productively as possible. That process has now gone into reverse. Banks have seen their capital bases shrink as write-downs have eaten into equity and off-balance-sheet assets have been reabsorbed. Now they need to restore their capital ratios to health to satisfy regulators and to reassure customers and investors.

For some, that has meant tapping new sources of capital, often sovereign-wealth funds. For most, it has meant reducing the size of their balance-sheets by selling off assets or by cutting back their lending. Quantifying the impact of this tightening is hard, but one calculation presented by a quartet of economists at America's Monetary Policy Forum in February suggested that if American financial institutions were to end up losing $200 billion, credit to households and companies would contract by a whopping $910 billion. That equates to a drop in real GDP growth of 1.3 percentage points in the following year. If the banks suffer, we all do.

Bank Of England Voted 8-1, Defeating Blanchflower's Call for Cut (Update2)

May 21 (Bloomberg) -- The Bank of England voted 8-1 to keep the benchmark interest rate at 5 percent this month as the majority of policy makers argued that a reduction risked letting inflation get out of control.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, said that cutting the rate may send the wrong signal to wage bargainers and companies, minutes of the May 8 decision show. David Blanchflower wanted a quarter-point reduction, arguing that faster inflation will ``have little tendency to persist'' and may undershoot the 2 percent target.

King said last week that inflation may exceed the government's 3 percent ceiling for several quarters, signaling that the bank has little room to cut the interest rate further after lowering it three times since December. He also said the bank needs to focus on the risk to consumer prices even though the economy may slip into a recession.

``A further reduction in bank rate this month could create the impression that the committee was trying to stabilize output growth rather than maintaining its focus on the inflation target,'' the majority of the panel said. ``Some slowing in the growth rate of output was likely to be necessary for inflation to settle close to the target around two years ahead.''

The pound rose as much as 0.2 percent against the dollar after the release of the minutes, and traded at $1.9671 as of 9:44 a.m. in London.

`Negative Growth'

The U.K. central bank last lowered the main rate in April. Blanchflower argued then for a half point cut, leading to a three- way split at the April decision as the majority opted for a quarter-point reduction and Timothy Besley and Andrew Sentance favored no change.

King said it's ``quite possible we will get an odd quarter or two of negative growth'' as he presented the bank's forecasts last week, which show annual growth rates slumping to around 1 percent by 2009 even if interest rates fall to 4.5 percent.

``There are still significant divisions about the outlook for growth and how the credit crunch will affect consumers,'' said Vicky Redwood, an economist at Capital Economics Ltd. in London, who formerly worked at the central bank. ``The minutes confirm that concerns about inflation are preventing the bank from cutting now.''

Letter to Darling

Inflation accelerated to 3 percent in April from 2.5 percent the month before, the biggest jump since 2002. British law requires King to write a letter of explanation to the Chancellor of the Exchequer Alistair Darling if inflation strays more than 1 percentage point from the target.

The governor has only written one letter since the Bank of England gained rate-setting independence in 1997, after inflation reached 3.1 percent in March last year.

The price of oil, which has more than doubled in the past year, rose above $129 a barrel for the first time yesterday. Wheat prices have increased 75 percent in the same period. Centrica Plc, Britain's biggest energy supplier, said this month it may raise household natural gas and power prices for a second time this year on ``stubbornly high'' fuel costs.

``Inflation is becoming an increasing concern and it's pushing the bank into a corner,'' said Matthew Sharratt, an economist at Bank of America Corp. in London. ``But households are coming under pressure at the same time. It doesn't get any easier for the Bank of England.''

House Prices

Policy makers predict that falling house prices, faster inflation and the global credit squeeze will blunt consumer spending this year. HBOS Plc, the U.K.'s biggest mortgage lender, said on May 2 that home values based on agreed transactions fell 0.9 percent from a year earlier, the first annual drop in more than a decade.

Billionaire investor George Soros said today the Bank of England should lower borrowing costs to help mortgage holders.

``The BOE ought to lower interest rates to make it easier for people to keep their houses,'' he said in an interview with Sky News.

U.K. mortgage lending fell 8 percent in April from a year earlier, the London-based Council of Mortgage Lenders, which represents U.K. home-loan providers, said today. The CML also said it expects house prices to drop 7 percent this year.

The Bank of England benchmark rate is still the highest in the Group of Seven nations. The U.S. Federal Reserve's main rate stands at 2 percent. The European Central Bank has kept the benchmark at 4 percent and Japan's is at 0.5 percent.

U.K. policy makers ``will have a difficult summer,'' Andrew Lilico, managing director of Europe Economics, said in an interview on Bloomberg Television. ``They'll tough it out and once they go past the peak of inflation, they'll go back to cutting later in the year.''

Asian Stocks Fall the Most in a Week; Banks, BHP Billiton Drop

May 21 (Bloomberg) -- Asian stocks fell, dragging the benchmark index to its steepest slump in a week, on concern widening credit losses will erode bank earnings and slowing growth in Chinese demand will hurt raw-materials producers.

Mitsubishi UFJ Financial Group Inc. dropped the most in two months in Tokyo after forecasting profit will be little changed this year. Macquarie Group Ltd. slumped in Sydney after Morgan Stanley cut its forecast, and BHP Billiton Ltd. led declines among mining stocks after the brokerage said weaker demand from China may result in ``soft'' metals prices. PetroChina Co. climbed on speculation it will be allowed to raise prices.

``The credit-crunch concern hasn't totally gone away,'' said Marc Desmidt, Tokyo-based chief investment officer at BlackRock Japan Co., whose parent has about $1 trillion in assets. ``There's an ongoing debate on the direction of oil prices, and so far the bulls have it right.''

The MSCI Asia Pacific Index fell 1.1 percent to 151.86 as of 6:11 p.m. in Tokyo, the most since May 9. The measure extended yesterday's 0.6 percent slump after a six-day, 3.7 percent climb.

Most Asian benchmarks declined, led by Japan's Nikkei 225 Stock Average losing 1.7 percent to 13,926.30. China's CSI 300 Index and Hong Kong's Hang Seng Index erased earlier losses to advance 2 percent and 1.2 percent, respectively, buoyed by PetroChina and China Petroleum & Chemical Corp. on speculation price caps on refined oil products will be lifted.

Global Slump

Europe's Dow Jones Stoxx 600 Index fell the most in two months yesterday and the U.S.'s Standard & Poor's 500 Index retreated the most in two weeks as record oil prices weighed on the outlook for profits and analysts said the financial-market turmoil isn't over. Oppenheimer & Co. slashed earnings estimates for U.S. banks and said financial companies may write off more than $170 billion of additional reserves by the end of 2009. Futures on the S&P 500 were little changed today.

Mitsubishi UFJ, Japan's largest bank by value, dropped 4.5 percent to 1,008 yen, the steepest decline since March 17. The Tokyo-based company said yesterday it expects weaker economic growth to slow lending.

Rival Mizuho Financial Group Inc. fell 5 percent to 514,000 yen. Macquarie Group tumbled 4.5 percent to A$58.50 in Sydney after Morgan Stanley cut its share-price forecast, citing ``slowing momentum'' in earnings.

The gauge of finance stocks in the MSCI World Index has slumped 23 percent in the past year, the steepest decline among 10 industry groups, as the world's largest financial companies reported more than $380 billion in writedowns and credit losses.

Banks, Raw-Materials Drop

Raw-materials shares led today's retreat among the MSCI Asia Pacific Index's 10 industry groups, and a gauge of energy stocks was one of only two groups that gained. Financial stocks had the third-sharpest decline.

BHP, the world's biggest mining company, fell 3.6 percent to A$46.87, the sharpest decrease this month. Rio Tinto Group, the third-largest, dropped 3.2 percent to A$150.05.

``We believe China is seeing a significant destocking phase due to a substantial inventory build during the record cold spell in the first quarter,'' Wiktor Bielski, a mining analyst at Morgan Stanley, said in a note to clients. ``So demand appears weaker than underlying consumption.''

Cnooc Ltd., China's largest offshore oil producer, led gains by energy companies after speculation that supply won't keep up with demand pushed crude prices to a record $129.60 a barrel.

Cnooc gained 5.9 percent to HK$15.90, while Santos Ltd., Australia's third-largest oil and gas producer, rose 1.4 percent to A$19.80, its highest close.

China Rebound

Macarthur Coal Ltd., an Australian coal supplier, jumped 8.1 percent to a record close of A$19.86. ArcelorMittal, the world's largest steelmaker, bought a 14.9 percent stake and wants talks that may lead to a $4 billion takeover.

T&D Holdings Inc., Japan's second-largest publicly traded insurer, tumbled 5.5 percent to 6,570 yen, the biggest loser on the Nikkei. HSBC Holdings Plc cut its rating to ``underweight,'' saying ``current high valuations are unjustified.''

PetroChina, the nation's second-largest oil refiner, soared 6.6 percent to 17.86 yuan in Shanghai and 2.2 percent in Hong Kong. China Petroleum, the biggest refiner, jumped by the 10 percent daily limit to 12.55 yuan, while its Hong Kong-traded shares rose 4.3 percent.

``I heard the rumor about lifting the price caps and if they do raise them, obviously it's very good for the likes of PetroChina and Sinopec,'' said Chris Tang, chief investment officer in Hong Kong at Marco Polo Pure Asset Management, which manages about $200 million. ``People are looking for ideas and there's strong belief in the authorities' invisible hand.''

Chinese oil refiners need government approval to raise product prices in order to pass higher crude-oil costs on to customers. Officials at the country's top planning body weren't immediately available to comment when called by Bloomberg News.

Brazil IPOs Are Canceled as Prices Exceed Profits (Update3)

May 21 (Bloomberg) -- Brazil, the world's best-performing equity market, has more companies canceling initial public offerings than any nation except the U.S. after 66 percent of last year's new stocks were money-losers.

Norse Energy do Brasil SA, Banco Fibra SA, PST Eletronica SA and 17 other companies in Latin America's biggest economy postponed or withdrew IPOs in 2008, according to data compiled by Bloomberg. So far this year, three Brazilian companies went public, raising 780 million reais ($473 million), compared with 59 that sold 53.2 billion reais of new equity in 2007.

Investors abandoned the IPO market even as the Bovespa index rose 15 percent after most of last year's issues fell below their offer price. Brazilian companies that went public in 2007 after reporting a profit the year before sold shares at a median price- to-earnings ratio of 40.6 times, Bloomberg data show. That compares with 22.4 in China and 16.9 in India, where the economies are growing about twice as fast as Brazil.

``It was very clear that the market was probably overshooting,'' Roberto Egydio Setubal, chief executive officer of Banco Itau Holding Financeira SA, Brazil's second-largest non- government bank, said in an interview in Sao Paulo. ``This year probably will be more selective.''

The pace of IPOs typically rises when shares rally. In the U.S. where the Standard & Poor's 500 Index fell 3.7 percent this year through yesterday, 40 sales have been canceled. Elsewhere in the world the total is 58.

Bovespa Record

``When you're in a bull market, you get a lot of IPOs overpriced,'' said Mark Mobius, who oversees about $47 billion in emerging-market equities as the executive chairman of Singapore- based Templeton Asset Management Ltd. ``It's not only true of Brazil, it's true of other markets.''

The 66-stock Bovespa index climbed more than six-fold since the end of 2002 as rising demand for Brazil's sugar, steel and oil boosted profits at commodities producers and falling interest rates spurred faster economic growth. S&P awarded the country an investment grade credit rating for the first time last month.

The Bovespa rallied to a record yesterday and outperformed the 20 biggest equity markets this year amid a global retreat in share prices sparked by the collapse of the subprime-mortgage market. Benchmark indexes in China and India lost more than 15 percent. The Bovespa slid 1.7 percent to 72,294.80 at 4 p.m. New York time today.

Below IPO

Industries that accounted for most of Brazil's IPOs last year -- banking, real-estate and consumer products -- are underperforming the Bovespa after the central bank raised interest rates last month for the first time in three years to cool inflation.

Iguatemi Empresa de Shopping Centers SA, a Sao Paulo-based operator of malls that sold shares last February for 42 times 2006 earnings, is trading 18 percent below its initial offering price. Bolsa de Mercadorias & Futuros-BM&F SA, the derivatives exchange that merged with Bovespa Holding SA, dropped 8 percent since the Sao Paulo-based company sold shares in November for 100 times profit. Acucar Guarani SA, a sugar processor also based in Sao Paulo, retreated 26 percent since its offering in July for 52.7 times earnings.

The prospect for higher interest rates and weaker consumer spending suggests profit forecasts are overstated, said Nick Field, who helps oversee $27 billion in emerging market equities, including about $9 billion in Brazilian stocks, at London-based Schroders Plc.

`Massive Future Growth'

The central bank may increase its overnight rate target to 13.75 percent this year from 11.75 percent to curb the fastest rise in consumer prices since 2006, Sao Paulo-based Itau said this week. Deutsche Bank AG lowered its recommendation on Brazil's stock market today to ``neutral'' from ``overweight,'' saying higher interest rates and reduced demand from China may slow economic growth.

``In a world where you have more inflation concern and rising interest-rates, where there's more earnings uncertainties and macro uncertainties, people are less willing to pay for massive future growth and rather want growth now,'' Field said.

About 252 companies sold shares valued at $55.5 billion through IPOs worldwide this year, according to Bloomberg data. That's down from 478 deals and $85.1 billion during the same period in 2007, a record year for initial sales.

`More Time'

Norse, a Rio de Janeiro-based oil and gas explorer that canceled its sale last month, said it wants to gauge investor demand for other IPOs before reviving the offering. Norse planned to sell 23 million shares for about 18 reais each, or about 383 times reported profit for 2006, according to data compiled by Bloomberg.

``We're not urgently in need of funding so we can buy ourselves a little more time,'' said Anders Kapstad, chief financial officer of Norse Energy's Oslo-based parent Norse Energy Corp. ASA.

Banco Fibra, a Sao Paulo-based commercial lender, withdrew its offering this month after the U.S. subprime mortgage-market's collapse sent financial shares tumbling worldwide. The MSCI World Financials Index has declined about 15 percent since Banco Fibra filed its IPO prospectus in August with the nation's securities regulator. Cassio Von Gal, the firm's finance chief, said Banco Fibra may pursue a private share sale instead.

``All bank stocks are down,'' Von Gal said in a May 14 interview. ``It doesn't make sense to enter the market now.''

Importacao Exportacao e Industria de Oleos SA, an Araucaria- Brazil-based soybean oil producer, postponed its IPO in March. Luiz Antonio Cavet, chief financial officer of the family-owned firm, said ``cautious'' investors prompted Imcopa to wait until markets improve.

The company is selling debt to finance operations and plans to offer shares ``when the moment is favorable,'' Cavet said.

PST Eletronica, a maker of electronic security equipment for automobiles, this week canceled plans to sell shares. The Manaus- based company announced the stock plan in October, without disclosing the number or price of shares to be offered.

Rice Price Surge Is Defying Asia's Ingenuity

Commentary by Andy Mukherjee

May 22 (Bloomberg) -- The intolerable surge in rice prices presents Asia with a rather unpleasant dilemma.

Rough rice prices have doubled in the past year on the Chicago Board of Trade.

Nutritionally, it's the most important cereal for the Asian region, supplying between a quarter and 73 percent of all calories consumed in China, India, Pakistan, Bangladesh, Indonesia, Thailand, Sri Lanka and Cambodia, according to the International Rice Research Institute in Manila.

It will be unconscionable for Asian governments to pass on the full international cost of rice to their people; that could end up driving to destitution the 600 million people in the region who live on less than $1 a day.

On the other hand, as governments in Asian rice-growing regions try to shield their urban poor through price controls or export bans, the risk is that the signal to farmers to boost production will either become weak or even be lost completely.

And that could prolong the shortage for everyone else because Asia is also the biggest exporter of the commodity.

Just four countries -- Thailand, India, Vietnam and Pakistan -- accounted for 70 percent of the 30 million tons of the global trade in rice last year. With the exception of Thailand, the others have all decided to restrict exporters from supplying freely to the world market. Vietnam, however, has hinted at relaxing its export ban in anticipation of a good crop.

Policy makers in Asia are hoping that farmers will respond to $1,000-a-ton rice and grow more of it; at the same time they can't let their own consumers pay anywhere close to that amount, for that would cause food riots and topple governments.

Stagnant Yields

Taking the hit entirely on the government's budget isn't an option for most of these countries.

So how does public policy protect consumers and government finances from ruin and yet encourage farmers?

That's the challenge confronting Asian nations.

Complicating matters, yields aren't rising quickly enough even to compensate for population growth.

``In the major rice-growing countries of Asia, yield growth over the past five to six years has been almost nil,'' says the Manila-based IRRI. ``Globally, yields have risen by less than 1 percent per year in recent years.''

In the absence of a significant pickup in yields, rice farming in Asia is fast becoming an unviable proposition.

It costs about 5,350 rupees ($125) in seeds, fertilizers, labor and interest charges to grow 1 ton of paddy, or unmilled rice, in the southern Indian state of Andhra Pradesh.

Growing Risks

The government last year paid farmers $175 to $180 per ton to buy their crop for the public distribution system. For such a puny profit, who would want to grow paddy?

That isn't all. Prices for phosphate-and potassium-based fertilizers have doubled this year, and with crude oil rising to more than $130 a barrel, an early respite isn't in sight. The cost of transporting rice from producing to consuming centers is also increasing.

Besides, with global warming, there's a growing risk of adverse weather conditions turning the farmer's small profit into a big loss. Access to crop insurance remains limited. And that makes farming an even riskier business than before.

Myanmar's rice-sowing season has already been disrupted by Cyclone Nargis, which has killed more than 77,000 people, according to the official death toll.

Paddy farmers in the southern Indian state of Kerala sold their output for a fraction of the open-market price after heavy rains in March damaged the crop, which was ready for harvest.

Boosting Profits

Unless farmers are allowed to receive a substantially higher price for their produce, they don't have much of an incentive to bring a bigger crop to the market.

With risks being so high and returns low, it makes little sense for a small farmer to rent land to grow rice. He would rather go looking for a wage laborer's job in the city.

This trend, which is seen in various degrees across Asia, is also borne out by India's census statistics. Out of the additional 50 million people who were engaged in farming in 2001, compared with 1991, as many as 41 million were women.

The men are leaving the farm, and they are doing so because agriculture doesn't pay.

The crisis in rice won't end without making farming more profitable in Asia. Much progress can be made toward that objective even as the world awaits a second Green Revolution, which may or may not happen.

For a start, improvements are needed in building up storage capabilities, especially in countries such as Cambodia that produce a surplus but don't have adequate warehousing capacity. Efficient land-lease markets will permit consolidation among small landowners, boosting economies of scale and profits.

A rice cartel in East Asia, an idea proposed by Thailand, was a harebrained plan. Thankfully, it has been dropped. Solutions needed to balance the interests of the vulnerable Asian consumer and the distressed rice farmer must be more inventive -- and less fanciful.

Most Fed Officials Saw April Rate Cut as `Close Call' (Update4)

May 21 (Bloomberg) -- Most Federal Reserve officials viewed the decision to cut the benchmark interest rate as ``a close call'' in April, signaling they may hold off from further reductions.

``The risks to growth were now thought to be more closely balanced by the risks to inflation,'' minutes of the April 29-30 Federal Open Market Committee meeting, released in Washington today, said. Several policy makers judged ``it was unlikely to be appropriate'' to lower rates further unless data indicated a ``significant weakening'' in the outlook.

Stocks tumbled after the report stoked speculation Chairman Ben S. Bernanke and his colleagues are finished lowering borrowing costs as the threat of inflation rises. Questions about whether to lower the rate last month came even as officials cut their 2008 growth estimate by almost 1 percentage point.

``The Fed is wary about the economy, but cautious to act due to high inflation,'' said Christopher Low, chief economist at FTN Financial in New York. The report ``reinforced the idea of a pause'' from rate reductions, he said.

Investors anticipate officials will keep the rate at 2 percent when they next meet June 24-25. Fed officials cut the benchmark lending rate by a quarter point on April 30. The 2.25 percentage points of reductions this year were the fastest in almost two decades.

Warsh Remarks

Two district-bank presidents dissented from the April rate cut, while Fed Governor Kevin Warsh said today that central bankers should be ``inclined to resist'' calls for further moves ``even if the economy were to weaken somewhat further.'' Warsh made the remarks in a Washington speech.

The Standard and Poor's 500 Index dropped 1.6 percent to 1,390.71 at the close of New York trading. Treasury prices fell, raising yields on benchmark 10-year notes to 3.82 percent from 3.78 percent late yesterday.

In their April 30 statement, officials dropped previous language referring to ``downside'' risks to economic growth remaining even after the rate cut.

``The committee felt that it was no longer appropriate for the statement to emphasize the downside risks to growth,'' the minutes said today. Officials judged that the risk of another round of financial disruptions hobbling the economy had ``receded'' since their March meeting.

Growth Forecast

Fed officials lowered their 2008 economic growth projections to 0.3 percent to 1.2 percent from a January forecast of 1.3 percent to 2 percent. The figures represent the median estimates of the five current Fed governors and 12 district-bank presidents. Next year, the panel sees an expansion rate of 2 percent to 2.8 percent.

The group raised its expectations for inflation, excluding food and energy, to 2.2 percent to 2.4 percent this year, from 2 percent to 2.2 percent. The Commerce Department's so-called core personal consumption expenditures price index is seen rising 1.9 percent to 2.1 percent next year.

The April 30 statement said that ``substantial'' rate cuts over the past 12 months ``should help promote moderate growth over time.''

``Although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and that fact that some indicators suggested that inflation expectations had risen in recent months,'' the minutes said.

`Calibrated' Stance

Fed Vice Chairman Donald Kohn said yesterday that ``monetary policy appears to be appropriately calibrated for now to promote both rising employment and moderating inflation of the medium term.'' He also said the recovery in growth into next year may be ``relatively moderate'' as it will take time for investors to regain confidence and for housing demand to rise.

Traders see a 90 percent chance the FOMC will keep its target rate for overnight loans between banks at 2 percent when they next meet June 24-25, according to futures prices quoted on the Chicago Board of Trade. The contracts indicate a 23 percent likelihood officials will raise the rate in September.

``Most members viewed the decision to reduce interest rates at this meeting as a close call,'' the minutes said today, referring to the April 29-30 meeting.

Policy makers lowered their growth forecasts after economic figures showed a continued decline in housing and slump in consumer confidence to the weakest since 1980. Businesses have also cut payrolls for five consecutive months.

`A Crawl'

``Growth in consumer spending appeared to have slowed to a crawl in recent months and consumer sentiment had fallen sharply,'' the minutes aid. ``The outlook for business spending remained decidedly downbeat.''

Construction of U.S. single-family houses in April dropped to the lowest level in 17 years, the Commerce Department said last week. Residential investment, a component of gross domestic product, has declined for nine consecutive quarters.

Fed officials are also contending with a surge in oil prices that has both depressed confidence and spending on other items and pushed up inflation.

Crude oil surpassed $133 a barrel today for the first time and has climbed about 37 percent this year. Food prices rose at a 6.1 percent annual rate for the three months ending April, according to the Bureau of Labor Statistics.

The Labor Department's gauge of consumer prices rose 3.9 percent in the 12 months ending in April, the sixth straight month that the rate exceeded 3.5 percent.

``Participants expected the recent increases in oil and food prices to continue to boost overall consumer price inflation in the near term,'' the minutes said.

The Reuters/University of Michigan Survey of households showed inflation expectations for the coming 12 months rose to 5.2 percent in May, the highest level since 1982. Consumers' estimate for price gains over the next five years increased to 3.3 percent, the fastest since 1996.

U.S. Stocks Extend Drop on Fed Minutes; Financials Lead Retreat

May 21 (Bloomberg) -- U.S. stocks tumbled, sending the Standard & Poor's 500 Index to its biggest two-day drop since March, as the Federal Reserve signaled it is done cutting interest rates and record oil prices threatened to reduce profits at consumer companies.

Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. sent financial shares to their lowest since April 15. Target Corp. led retailers to their worst decline in a month and an index of airlines slid to an all-time low as crude climbed above $133 a barrel. Moody's Corp. slumped the most since 1999 after the credit ratings company said it is investigating whether it mistakenly assigned Aaa ratings to debt securities that later fell in value.

The S&P 500 lost 22.69 points, or 1.6 percent, to 1,390.71. The Dow Jones Industrial Average slid 227.49, or 1.8 percent, to 12,601.19. The Nasdaq Composite Index fell 43.99, or 1.8 percent, to 2,448.27. Four stocks retreated for every one that rose on the New York Stock Exchange.

``The American market is a bottomless pit right now,'' said Peter Schiff, president of Darien, Connecticut-based brokerage Euro Pacific Capital, which has more than $1 billion in customer accounts. ``The Fed can't cut rates any more. Oil is $132 a barrel and rising. Any company that collects revenues from American consumers is going to have terrible earnings, and share prices are going to fall.''

`Close Call'

All 10 industries in the S&P 500 slid after the minutes from the Fed's April meeting suggested record energy costs and rising public expectations for inflation threatened their ability to continue cutting rates. Policymakers also reduced their projections for economic growth this year by almost a full percentage point and raised their forecasts for inflation amid curtailed bank lending and a record rise in the prices for oil

``Most members viewed the decision to reduce interest rates at this meeting as a close call,'' the minutes said. ``Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term.''

The S&P 500's 2.5 percent drop over the past two days was the benchmark's biggest decline since the Federal Reserve brokered JPMorgan Chase & Co.'s buyout of Bear Stearns Cos. in March.

Citigroup slid 4.8 percent to $21.06, while Bank of America lost 2.2 percent to $34.63 and JPMorgan fell 2.9 percent to $42.42.

Financials Tumble

The S&P 500 Financials Index slumped for a fourth day, losing 2.3 percent. The index has tumbled 34 percent over the past year, allowing technology companies to surpass the group as the biggest industry in the S&P 500, after global banks and securities firms racked up $379 billion in asset writedowns and credit losses related to the collapse of the subprime mortgage market.

Moody's plunged 16 percent to $36.91. Some senior staff at Moody's were aware in early 2007 that constant proportion debt obligations, funds that used borrowed money to bet on credit- default swaps, should have been ranked four levels lower, the Financial Times said, citing internal Moody's documents. Moody's altered some assumptions to avoid having to assign lower grades after it corrected the error, the paper said.

McGraw-Hill Cos., the owner of Moody's rival Standard & Poor's, tumbled 5.5 percent to $41.18.

Lehman Brothers Holdings Inc. lost 5.8 percent to $39.56 after Merrill Lynch & Co. reduced earnings forecasts. Lehman will probably earn 6 cents a share in the quarter that ends May 30, down from Merrill's earlier estimate of 82 cents. Merrill analyst Guy Moszkowski lowered his full-year estimate to $2.80 per share from $3.88.

Crude's Rally

Target, the second-largest U.S. discount chain, tumbled 2.6 percent to $52.87, leading retailers in the S&P 500 to a 2.5 percent drop as a group.

Crude for July delivery climbed $4.19, or 3.3 percent, $133.17 a barrel after U.S. stockpiles unexpectedly dropped, spurring concern that rising fuel bills will leave consumers with less money to spend elsewhere.

At least five banks raised price forecasts for crude in the past week and options contracts betting that oil will exceed $200 a barrel in December have risen 46 percent this week, as futures for delivery in 2016 topped $141.

Homebuilders fell the most since March 26 and accounted for five of the top 10 declines in the S&P 500 on concern that higher borrowing costs will reduce demand. D.R. Horton Inc., the largest U.S. builder by market value, slumped 6.2 percent to $13.43. Smaller rival Lennar Corp. tumbled 7.4 percent to $17.43.

`Another Hurdle'

``Those who expected the Fed would continue to be able to reduce rates and thus provide a safety net to the economy and consumers who are in trouble are going to have to question that,'' said Michael Barron, chief executive officer of Knott Capital Management in Exton, Pennsylvania, which manages $1 billion. ``It's another hurdle the financial sector has in front of it.''

The AMEX Airline Index slumped 12 percent to an all-time low after Soleil Securities downgraded the industry to ``neutral'' from ``outperform'' and AMR Corp.'s American Airlines said it will slash U.S. capacity as much as 12 percent, retire as many as 85 jets and cut jobs to blunt surging fuel prices and slowing demand.

UAL Corp., parent of United Airlines, lost 30 percent to $8.15. Continental Airlines Inc. slid 13 percent to $14.20. AMR lost 24 percent to $6.22. Boeing Co., the world's second-biggest commercial airplane maker, fell 4.6 percent to $81.19.

Bankruptcy Speculation

``We now expect AMR to have trouble avoiding bankruptcy by sometime in 2009,'' Soleil analyst James M. Higgins wrote in a note to clients.

United spokeswoman Robin Urbanski didn't immediately return calls for comment. AMR spokesman Andy Backover said ``We've done a lot of work in recent years to avoid bankruptcy and to put ourselves in a better position to weather today's uncertainty.''

Medtronic Inc. climbed 3 percent to $50.43. Goldman Sachs Group Inc. upgraded the shares to ``buy'' from ``neutral'' after the company's fiscal fourth-quarter profit beat analysts' estimates yesterday as defibrillator sales recovered from a recall and the heart stent Endeavor began selling in the U.S.

Micron Technology Inc. climbed 1.8 percent to $8.36. The largest U.S. maker of computer-memory chips was upgraded to ``buy'' from ``hold'' at Deutsche Bank AG, which said it expects further price increases for dynamic random access memory.

Intuit Inc. gained the most in a month, rising 93 cents, or 3.4 percent, to $28.14. The world's largest maker of tax- preparation software said third-quarter profit rose 21 percent after more customers used its TurboTax software to file U.S. tax returns. Sales advanced 15 percent, topping analysts' estimates.

The Russell 2000 Index, a benchmark for companies with a median market value 95 percent smaller than the S&P 500's, fell 1.2 percent to 727.11. The Dow Jones Wilshire 5000 Index, the broadest measure of U.S. shares, dropped 1.6 percent to 14,084.22. Based on its retreat, the value of stocks decreased by $282 billion.

Summer Reading

By Thomas Sowell

Some parents who are concerned about their children receiving a steady diet of liberal-left indoctrination in schools and colleges regard the summer vacation as a time to show these young people a different way of looking at things, with readings presenting viewpoints that are unlikely to be heard in classrooms that have become indoctrination centers.

Fortunately, there is a growing body of literature-- both books and articles-- presenting a very different viewpoint in readable language.

The academic year often ends with commencement speakers who have been in government, academia, foundations or various crusading movements, who tell the graduates how much nobler it is to go into such organizations, rather than into business.

Such self-flattering talk is seldom challenged by educators. But an outstanding recent book, "The Best-Laid Plans" by Randal O'Toole, gives a richly documented account of government actions and their consequences, and shows a far from flattering side of politicians, "experts," and environmentalists-- who have ruined cities and suburbs in countries around the world.

Highly praised projects created by leading "experts" have repeatedly led to economic and social disasters, whether in Europe or the United States. The fundamental problem is that people don't want to live the way elites want them to live.

A classic example was the Pruitt-Igoe project in St. Louis, which had an extraordinary vacancy rate of 25 percent, rising eventually to 65 percent, before the whole project was demolished.

But, tragically, the assumptions behind such projects have not been demolished.

One statistic in "The Best-Laid Plans" shoots down one of the biggest lies of the environmentalist movement-- that laws are needed to keep development from paving over the last remnants of open space. That statistic is that all the urban areas in the United States, put together, cover less than 3 percent of the land.

This statistic is all the more remarkable when you realize that O'Toole uses the Census definition of "urban"-- any community with at least 2,500 people. That would include towns and villages, as well as cities.

Another remarkable and eye-opening book is "Liberal Fascism" by Jonah Goldberg. So many liberals use the term "fascism" to condemn conservative ideas that it may come as a revelation to many that the original fascism was in fact a doctrine having far more in common with the left than with conservatism.

While people on the left may deny that today, when fascism first emerged back in the 1920s it was widely recognized as a kindred doctrine by the leftists of that era.

Only after the international aggressions of Mussolini and Hitler during the 1930s made them pariahs did the left start reclassifying fascists as being on the right.

Since this is an election year, there may be more interest than usual in Barack Obama. Best-selling author Shelby Steele's book on Obama, titled "A Bound Man," gives both facts and insights that will take the reader far deeper than most media accounts.

Among my own books, the one that will probably be of the most interest to young people with no knowledge of economics is "Basic Economics." Apparently many people find it easier to understand than most economics books, since it has been translated into six other languages overseas.

My latest book on economics, however, is the recently published "Economic Facts and Fallacies." It looks in-depth at fallacies about such things as housing, income, race, sex discrimination, the economics of academia and the Third World.

Fallacies are not just crazy ideas. Usually they are notions that sound very plausible, which is what enables them to be used by politicians, intellectuals, the media, and all sorts of crusading movements, to advance their causes or their careers.

It is precisely because most of the popular fallacies of our time, which are always especially popular during election years, sound so plausible that we need to stop, before we get swept along by rhetoric, and scrutinize the underlying flaws that turn brilliant-sounding "solutions" into recipes for disaster.