A Failed Global Recovery

An interesting read.

Aivars Lode

A Failed Global Recovery
July 1, 2011
Stephen S. Roach
Morgan Stanley Asia
The global economy is in the midst of its
second growth scare in less than two years.
Get used to it. In a post-crisis world,
these are the footprints of a failed recovery.
The reason is very simple. The typical business cycle has a
natural cushioning mechanism that wards off unexpected
blows. The deeper the downturn, the more powerful
the snapback and the greater the cumulative forces of
self-sustaining revival. Vigorous V-shaped rebounds have
a built-in resilience that allows them to shrug off shocks
relatively easily.
But a post-crisis recovery is a very different animal. As
Carmen Reinhart and Kenneth Rogoff have shown in their
book This Time is Different, over the long sweep of history,
post-crisis recoveries in output and employment tend to be
decidedly subpar.
The global economy is in the midst of its second
growth scare in less than two years. Get used to
it—there are more to come in the years ahead.
Such weak recoveries, by definition, lack the cushion
of V-shaped rebounds. Consequently, external shocks
quickly expose their vulnerability. If the shocks are sharp
enough—and if they hit a weakened global economy
that is approaching its “stall speed” of around 3% annual
growth—the relapse could turn into the dreaded doubledip
recession.
That is the risk today. There can be no mistaking the
decidedly subpar character of the current global recovery.
Superficially, the numbers look strong: world GDP
rebounded by 5.1% in 2010, and is expected to rise another
4.3% in 2011, according to the International Monetary
Fund. But because these gains follow the massive contraction
that occurred during the Great Recession of 2008-09, they
are a far cry from the trajectory of a classic V-shaped recovery.
Indeed, if the IMF’s latest forecast proves correct, global
GDP at the end of 2012 will still be about 2.2 percentage
points below the level that would have been reached had the
world remained on its longer-term 3.7% annual-growth path.
Even if the global economy holds at a 4.3% cruise speed—
a big “if,” in my view—it will remain below its trend-line
potential for over eight years in a row, through 2015.
Post-crisis recoveries tend to be weak—leaving
them far more vulnerable to ever-present
shocks than normal cyclical rebounds.
This protracted “global output gap” underscores the
absence of a cushion in today’s world economy, as well as its
heightened sensitivity to shocks. And there have certainly
been numerous such blows in recent months—from
Europe’s sovereign-debt crisis and Japan’s natural disasters
to sharply higher oil prices and another setback in the US
housing recovery.
While none of these shocks appears to have been severe
enough to have derailed the current global recovery, the
combined effect is worrisome, especially in a still-weakened
post-crisis world.
Most pundits dismiss the possibility of a double-dip
recession. Labeling the current slowdown a temporary
“soft patch,” they pin their optimism on the inevitable
rebound that follows any shock. For example, a boost is
expected from Japan’s reconstruction and supply chain
resumption. Another assist may come from America’s
recent move to tap its strategic petroleum reserves in an
effort to push oil prices lower.
But in the aftermath of the worst crisis and recession of
modern times—when shocks can push an already weakened
global economy to its tipping point a lot faster than would
be the case under a stronger growth scenario—the escape
velocity of self-sustaining recovery is much harder to
achieve. The soft patch may be closer to a quagmire.
Note: This essay was published on July 1, 2011 by Project Syndicate and distributed to their global network of newspapers, magazines, and other media outlets.
This conclusion should not be lost on high-flying
emerging-market economies, especially in Asia—currently
the world’s fastest growing region and the leader of what
many now call a two-speed world. Yet with exports still
close to a record 45% of pan-regional GDP, Asia can hardly
afford to take external shocks lightly—especially if they hit
an already weakened baseline growth trajectory in the postcrisis
developed world. The recent slowdown in Chinese
industrial activity underscores this very risk.
Policymakers are ill prepared to cope with a steady stream
of growth scares. They continue to favor strategies that are
better suited to combatting crisis than to promoting postcrisis
healing.
That is certainly true of the United States. While the
Federal Reserve’s first round of quantitative easing was
effective in ending a wrenching crisis, the second round
has done little to sustain meaningful recovery in the labor
market and the real economy. America’s zombie consumers
need to repair their damaged balance sheets, and US
workers need to align new skills with new jobs. Open-ended
liquidity injections accomplish neither.
European authorities are caught up in a similar mindset.
Mistaking a solvency problem for a liquidity shortfall,
Europe has become hooked on the drip feed of bailouts.
However, this works only if countries like Greece grow their
way out of a debt trap or abrogate their deeply entrenched
social contracts. The odds on either are exceedingly poor.
Policymakers are ill prepared. They continue
to favor strategies that are better suited
to combatting crisis than to promoting
post-crisis healing.
The likelihood of recurring growth scares for the next
several years implies little hope for new and creative
approaches to post-crisis monetary and fiscal policies.
Driven by short-term electoral horizons, policymakers
repeatedly seek a quick fix—another bailout or one more
liquidity injection. Yet, in the aftermath of a balance-sheet
recession in the US, and in the midst of a debt trap in
Europe, that approach is doomed to failure.
Liquidity injections and bailouts serve only one purpose—
to buy time. Yet time is not the answer for economies
desperately in need of the structural repairs of fiscal
consolidation, private-sector deleveraging, labor-market
reforms, or improved competitiveness. Nor does time
cushion anemic post-crisis recoveries from the inevitable
next shock.
It’s hard to know when the next shock will hit, or what
form it will take; otherwise, it wouldn’t be a shock. But,
as night follows day, such a disruption is inevitable.
With policymakers reluctant to focus on the imperatives
of structural healing, the result will be yet another growth
scare—or worse. A failed recovery underscores the risks of an
increasingly treacherous endgame in today’s post-crisis world.
Stephen S. Roach, a member of the faculty at Yale
University, is Non-Executive Chairman of Morgan Stanley
Asia and author of The Next Asia (Wiley 2009).
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Contact: Noel Cheung at Morgan Stanley Corporate Communications at
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Commodities Beckon Banks

This article is really interesting when you read it, I encourage you to ask the question: Can a Fox mind the chickens? Just another way that the commodity market is manipulated!

Aivars Lode

BUSINESS JULY 5, 2011.
Commodities Beckon Banks
Resource Storage Gives Lenders Profits in Tough Times, but Some Clients Complain of Bottlenecks.

Text By CAROLYN CUI And TATYANA SHUMSKY
About 600 miles from Wall Street, Goldman Sachs Group Inc. employees are busy doing deals. WSJ's Brian Baskin reports on one of the newest profit centers for big banks...warehousing metals and commodities. But instead of a sleek office tower, they work in a rundown warehouse deep in an industrial section of Detroit. And rather than trading in stocks or bonds, they move metal—lots of metal.

Goldman's warehouse on the banks of the Detroit River is one of more than 100 storage facilities controlled by the giant securities firm around the world. The warehouses are part of Wall Street's effort to forge a new frontier in the commodities markets: warehousing metal.

In the past 18 months, Goldman, J.P. Morgan Chase & Co. and trading firms Glencore International PLC and Trafigura Beheer BV have snapped up warehouse operators, all of them accredited to house metal traded through the London Metal Exchange, or LME. The buying binge means the four firms now are landlords to about two-thirds of the LME's entire metal stocks, from aluminum to copper to zinc.

LME metal stocks represent a small portion of the global supply. For example, LME's total aluminum stocks are about 4.5 million tons, or about 10% of the world's annual supply.

For Wall Street, warehouses are a way to earn extra income, especially as core businesses like trading are suffering. The facilities represent a relatively small but profitable way to bet on commodities markets without actually trading, the firms said.

But the growing muscle of securities firms in the metal-storage business is riling users and traders, who say the firms have both a bird's-eye view of supply and demand and the ability to control what goes in and out of their warehouses. These traders worry the firms could exploit their knowledge. The new owners say they keep their trading arms and warehouse operations separate, and there is no evidence to suggest they share information.

Traders and metal users have complained to the U.K.'s competition watchdog and the LME about companies acting as both trader and warehouse keeper. On Thursday, the Office of Fair Trade said the complaints lacked substance, and the agency won't investigate. The LME says it has no evidence to support claims the warehouses are used to gain an unfair advantage.

Goldman's operations in Detroit are at the center of the controversy, because aluminum prices are higher in that area than the trading price in London, and Goldman controls most of the warehouses in Detroit. Warehouses like the one along the Detroit River hold about one million tons of aluminum, or almost 25% of the LME's stocks.

Metal users such as beverage giant Coca-Cola Co. and can maker Novelis Inc. have expressed concern to the LME that the Detroit warehouses send out too little of the commodities they need. The LME has responded by instructing warehouse to release more commodities.

"This is inappropriate," says Nick Madden, chief procurement officer at Novelis, referring to the release limits and the wait to receive aluminum. Warehouses in Detroit owned by Goldman are only required to release 1,500 metric tons of metals a day. The warehouse only rarely surpasses this limit, according to LME data.

Novelis, a beverage-can maker, is the largest user of aluminum in the U.S. "We see it as very unhealthy for the market," he says. "The ultimate bill goes to the consumers."

Procurement officers at Coke and Novelis have said the limited releases are driving metal costs higher. A Goldman spokesman says its warehouse unit "is fulfilling the LME's requirements."

With record levels of commodities piling up, companies that own the warehouses are raking in nearly $1 billion in rental revenue each year, according to LME data.

Here is how it works: If a producer or merchant needs to store some aluminum, for example, it sends the metal to a warehouse, paying rent every day. In Detroit, Goldman charges 41 cents per metric ton of aluminum per day, or about $150 a year, according to LME data.

The rent is offset by big cash incentives warehouses pay to attract metal. But with millions of tons in storage, even a difference of a few dollars of income per ton can quickly add up.

The business was a backwater in the commodities markets for decades, dominated by small, independent operators. Then the financial crisis put the industry on the radar screens of Wall Street firms looking for new ways to make money. The firms correctly predicted a slump in metal demand during the recession, increasing the need for storage.

In 2010, J.P. Morgan acquired Henry Bath & Son as part of the New York bank's purchase of RBS Sempra Commodities. Goldman bought Metro International Trade Services LLC, a Romulus, Mich., warehousing company, for an undisclosed sum. Trafigura, the world's second-largest metal trader after Glencore, purchased U.K.-based NEMS Ltd. Glencore paid $209 million for Pacorini Metals, the metal-storage business of Pacorini Group, an Italian, family-run firm.

"The warehouses give the banks exposure to commodities without them having to be involved in price volatility," said Clare Eilbeck, a metals researcher at Brook Hunt, a subsidiary of commodities consulting firm Wood Mackenzie.

Simon Collins, a director at Trafigura, says the Amsterdam-based firm sees its warehouses as a "recession hedge" when other businesses slow. So far, the frenzy of warehouse buying is paying off. Glencore's Pacorini earned profits of $31 million in 2010 on revenue of $220 million, according to its recent initial-public-offering prospectus. Henry Bath was one of the biggest contributors to J.P. Morgan's base-metal business in the first five months of this year, according to people familiar with the matter. A J.P. Morgan spokeswoman declined to comment. A Glencore spokesman also declined to comment.

In Detroit, Goldman often offers a discount to attract customers to its warehouses but sometimes forces buyers to wait seven months or longer to get their inventory back, according to some users and LME data.

As a result of recent complaints, the LME will require most warehouses to release more metal on a daily basis starting next April. But analysts say the exchange's move isn't enough to alleviate the delays.

In New Orleans, warehouses owned by Goldman, J.P. Morgan, Glencore and Trafigura have accumulated 60% of all the LME's zinc stock. Right now, traders say, the delay in getting metal out of storage is about five days, but traders are worried that might increase—like in the aluminum market—as stocks rise but output remains constant. Greater stocks inside warehouses mean more clients potentially requesting the release of stored commodities.

"Clients are clearly not pleased with metals being tied up for many months," said Mike Frawley, global head of metals at Newedge USA LLC. Clients have little choice but to wait or find another source, such as buying directly from a producer or merchant.

But getting metal quickly from other sources for faster delivery costs extra. For aluminum, buyers are charged a premium of about $187 a ton, according to Karen McBeth, global director of Platts Metals Group, a commodities-information provider. Aluminum currently trades at $2,486 a metric ton at LME. Zinc users are being charged about $165 a ton more than the LME trading price.

There will be yet another problem if the economy picks up and buyers increasingly need metal they are storing in warehouses. "I am very worried," said Steven Spencer, chief executive of Traderight Ltd. "We have never seen stocks this high. It's going to be very hard to move so much metal around."

Write to Carolyn Cui at carolyn.cui@wsj.com and Tatyana Shumsky at tatyana.shumsky@dowjones.com