Weekly Markets

Precious Metals

Gold futures for April Delivery were down 1.6% for the week. On the New York Mercantile Exchange, gold for April delivery closed at $439.70 an ounce down from the close of $446.80 an ounce last Friday. The live market spot price closed at $438.80.

Silver was down 1.7% for the week. May silver fell 1 cent on Friday to end at $7.397 an ounce, moving from $7.42 to $7.285. Spot silver last fetched $7.36/39 from $7.34/37 previously.

Platinum was up just over 1% for the week. April platinum rose 50 cents to $880 an ounce. Spot edged to $874/880.

Palladium for June delivery closed the week at $202.80 to be largely unchanged for the week and is consolidating after the 15.6% gain of the week before. Spot palladium was at $199/202.

On Tuesday, the U.S. Federal Reserve is widely expected to lift rates by a quarter percent to 2.75 percent. Rate hikes tend to be negative for most asset classes, equities, bonds and property and the wider economy. A rising interest rate environment makes investors less complacent and more conscious of risk and thus look to safe haven assets such as cash, treasury bills and precious metals. Former Undersecretary of the Treasury and current President of Harvard, Lawrence Summers, wrote an excellent study of this phenomenon in a paper entitled "Gibson's Paradox and the Gold Standard" which posited that the price of gold must be inverse to the return on financial assets.

In 1968 the Fed Funds rate was 5.66% and during the stagflationary 1970's it rose to 16.39% in 1981. Returns on financial assets were poor during those 14 years. Precious metals were to top performing asset class of the decade with gold going from $35 dollars an ounce in 1968 to $880 in 1980 and silver going from $1.95 to nearly $50 dollars an ounce.

The demand for investment grade gold bullion has increased in the first half of 2004 to 219 metric tons from 156 metric tons in the first half of 2003. This represents a 40% increase in demand. Total gold supply has fallen by 9.1% in the same time period.

Due to the falling price of gold, silver, platinum and indeed the entire commodity complex in the 1980's and 1990's there has been a underinvestment in the industries - agriculture, exploration and mining that produce these commodities. The infrastructure, equipment and even the expertise in these sectors is not as strong as it once was and thus it is believed that it will be a number of years before the recent surge in demand from the industrialised world and the newly industrialising world, particularly China and India, can be met with a consequent increase in supply to meet that demand. This is why most commodity analysts and many financial commentators believe we are in the early stages of a multi-year bull market in hard tangible finite resources.

Gold is the safest way for an investor to gain exposure to the emerging Asian markets of China and India. As if one buys a Chinese stock or property or a cyclical commodity such as copper, an investor has the risk that there may be a slowdown in these individual economies.

Gold's distinctive properties as being nearly the only asset class with an inverse relationship to other asset classes and the wider economy make it a safe way to gain exposure to the rise of China and India. In both countries gold is very deeply rooted in their culture and indeed their psyche and their growing middle classes are expected to greatly bolster demand for gold both for jewellery and for investment and saving purposes. Gold is the only commodity which is also a universal currency and monetary asset and thus the only commodity and one of the only assets which protects the investor in deflationary, inflationary or stagflationary times.

Oil and the Irish Economy

Light, sweet crude made a new record closing high gaining $0.32 to $56.72 as traders contemplate rising demand, tighter supplies and geopolitical tensions. Oil hit an intraday record high of $57.60 on Thursday. For the week, oil was higher by $2.29 or 4.21%.

Oil prices are more than 50% higher than a year ago. The oil price will need to climb above $90 a barrel to approach the inflation-adjusted peak set in 1980. The impact of the oil price hikes has been quite muted to date. Markets despite increasing nervousness have so far remained sanguine. Gasoline prices in the US are now at record highs and they are also increasing in the EU.

Oil in Euro terms is up some 65% in the last 15 months . In January 2004 oil was at EUR26 per barrel and it is now at EUR43.

On oil prices, Dan McLaughlin of Bank of Ireland says that prices could rise still further in the short time. He predicts that they will settle at around EUR45 a barrel, but says that they will not fall back to EUR20-25. He says that this could have a positive impact for home buyers, because if oil prices stay high, the European Central Bank will keep interest rates low.

We hope Dan is right about oil prices settling at EUR45, oil prices not affecting the Irish property market and this being the best of all possible economic worlds. However, we believe rising oil prices will not have a positive impact on home buyers as they act like an extra tax and leave home buyers with less income. Higher oil prices will have inflationary effects globally as witnessed in British Airways and Fedex's recent introduction of fuel surcharges. It is important to note that higher oil prices often take to 60 months to completely permeate the wider economy.

In our increasingly globalised economy where all economies are increasingly interlinked through trade, labour and capital flows, escalating oil prices will have impacts on oil importing nations, many of which are already experiencing slow growth rates. Thus, if this current burgeoning oil crisis lingers long enough, a worldwide recession may evolve.

Higher oil prices result in higher fuel, fertilizer, and pesticide prices in the agricultural sector which will feed through into food prices. Not to mention the fact that agricultural commodities have in themselves already experienced significant price increases. As higher energy costs feed through into the prices of nearly all goods as the transportation of these goods becomes more expensive and retailers will gradually pass these increasing transportation costs on to consumers. Oil and energy prices are the most important factor in causing inflation as witnessed in the 1970's and unfortunately inflation will most likely result in an increase in interest rates in the Eurozone and not the maintenance of interest rates at historically low levels.

To suggest that high oil prices aren't a threat to one of the most globalised economies in the world as they will keep interest rates low in the EU is disingenuous. The price of Irish property is overwhelmingly dependent on the direction of the U.S. economy. The price of oil in dollar terms is up 50% since March 2004 and nearly 500% in just six years and the increasing oil prices and burgeoning inflation will likely result in rising interest rates in the U.S. and possible stagflation - a combination of high inflation and high growth. If the U.S. economy experiences economic contraction so will the global and Irish economy. The fate of the Irish property market is in the short to medium term wholly dependent on the health of the U.S. economy.

Europe still imports 80 percent of its energy needs and Ireland imports some 87% of it's energy needs. Ireland's per capita consumption of oil, while not as bad as the US' is higher than the EU average. The US uses some 25 barrels per capita per year; the EU some 13 barrels and Ireland some 16 barrels. Emerging India only uses 0.9 barrels per day. Any major shutdown of Persian Gulf, Russian or Venezuelan oil exports through a political act, terrorism and or a war on Syria or Iran would likely affect economic growth and damage the world economy. Complacency in this regard is not responsible.

The Irish government and political and economic class should not remain sanguine regarding this issue and instead we as a nation should look to create a large national oil reserve to cushion our economy from any possible oil crisis. This is a short term measure. More importantly, energy conservation, public transport, tax incentives for energy efficient appliances and vehicles and alternative energy sources especially wind should all be incentivised and promoted. This is not now the sole preserve of the Green Party and environmentalists as even senior executives in the major oil companies are increasingly advocating such policies. Policies which may have seemed slightly radical some years ago now are being accepted as practical, sensible and essential by both 'the Left' and 'the Right'. David O'Reilly Chevron Texaco Chairman, said in a recent speech, "Oil is no longer in plentiful supply. The time when we could count on cheap oil and even cheaper natural gas is clearly ending."

Other Commodities

Commodities price gains were broad-based, with the Reuters Commodities Research Bureau's Index rose 0.5% to 320.15 from 318.61 last Friday. It reached a new high of 323.33 points on Wednesday, its highest level for 24 years. The CRB is up some 12.7% already this year.

The Reuters CRB Index ( the 17 basic components include hard tangible assets such as Metals, Textiles and Fibers, Livestock and Products, Fats and Oils, Raw Industrials, Foodstuffs). One of the CRB index's greatest strengths is the fact that there is an equal weighting of all of its 17 components. This weighting assures that no price increase in any single commodity, like oil, can significantly skew the entire index. Significant moves in the CRB are only possible when the majority of its component commodities are moving in unison with a particular primary trend. The most important commodities - gold, oil, and silver only account for 3/17th of the entire index.

The Goldman Sachs Commodities Index increased 2.3% after last weeks 3.4% gain, increasing year-to-date gains to 20.4%. The GSCI is a world production-weighted commodity index which next year will be composed of 24 liquid exchange traded futures contracts. The GSCI includes energy, industrial metals, precious metals, agricultural and livestock products.

Copper futures jumped to the highest level for more than 16 years, powered by aggressive Chinese demand and falling inventories. Copper rose to as high as 3,305 dollars per tonne in Wednesday trading. The International Copper Study Group forecast that world production of the metal would remain in deficit in 2005 and 2006. "Given extremely low inventory levels, the lack of sufficient additional supply and very robust demand growth will certainly keep prices supported at high levels for longer," Barclays Capital analyst Ingrid Sternby said. By Friday, three-month copper prices rose to 3,257 dollars per tonne on the London Metal Exchange from 3,240.50 dollars the previous week.

Aluminium fell below 2,000 dollars per tonne after surpassing the symbolic level the week before for the first time in 10 years. Three-month aluminium prices fell to 1,972 dollars per tonne from 2,005 dollars.

Nickel prices dropped to 15,900 dollars per tonne from 16,100 dollars.

Lead prices retreated to 955 dollars per tonne from 975 dollars.

Zinc prices declined to 1,370 dollars per tonne from 1,436 dollars.

Tin prices eased to 8,455 dollars per tonne from 8,500 dollars.

Coffee hit fresh multi-year high points due to forecasts of lower supplies

Corn, despite a bumper crop and record inventories last year, prices have risen from a 34-month low last month. It has since has advanced 16% to $2.22 a bushel. Due to record energy prices corn is increasingly being used in the production of ethanol (ethyl alcohol or grain alcohol).

Ethanol is a homegrown fuel that is better for air quality as it reduces carbon dioxide emissions. It also helps create greater energy independence by reducing imports of foreign oil. Most liquid fuels (gasoline, diesel, natural gas, propane) come from fossil hydrocarbons. Unlike them, ethanol is produced from renewable biological feedstocks, such as agricultural crops and forestry by-products. Carbon dioxide is released into the atmosphere when ethanol (like other fuels) is burned in an automobile engine. However, this carbon dioxide is recycled into organic tissue during plant growth. Only about 40 percent or less of the organic matter is actually removed from farm fields for ethanol production. The rest is returned to the soil as organic matter, increasing fertility and reducing soil erosion. In 2004, U.S. ethanol facilities set new production records and consumers used more than 3 billion gallons of ethanol in their automobiles. 2005 looks to be another record-setting year.

Long Term Commodity Cycles

Food prices in China, year on year for February were up 8.8%. The price of fresh eggs rose by as much as 16.3% while vegetables rose by 13.1% in the month of February alone.

Locusts which can form swarms of tens of millions taking up hundreds of square kilometres (miles), have destroyed crops in central, western and northern Africa. Officials in the agriculture ministry in Algeria claim they have won a war on millions of crop-eating locusts which have plagued its agriculture industry over the past two years. Algeria's 2004-2005 crop is forecast to produce four million tonnes of cereals, half of its annual needs.

Rice in Mali is up 15% compared with last year.after last year's locusts swarms and poor rains combined to shrivel crops. Locally produced grains like millet and sorghum have been even more affected. Millet surged 33 percent to 97 CFA (20 US cents) a kilo, while sorghum was now 50 percent more expensive at 102 CFA (21 US cents). But the hardest-hit product was corn, which rocketed 65 percent to 109 CFA (22 cents). "The price of the essential food stuffs has gone up so much, it's like they've taken the elevator," said Amadou Guindo, a teacher on the outskirts of the capital Bamako. Government officials have said more than a million people will need food aid in 2005. The authorities had this week recommended that almost 21,000 tonnes of cereals should be distributed free of charge to people living in the worst-hit regions.

In the Sudan poor cereal harvests and a substantial increase in the prices of basic food commodities, particularly sorghum which has more doubled in the last year, have led to fears of a potential food crisis in different parts of Sudan this year, UN officials said.

Many commodity analysts believe that agricultural commodities and cereals in particular will be increasingly affected by drought, floods and other extreme out of the ordinary climactic conditions due to increasing global warming.

Although the United States has long consumed the lion's share of the world's resources, this situation is changing fast as the Chinese economy surges ahead, overtaking the United States in the consumption of one resource after another.

Among the five basic food, energy, and industrial commodities -- grain and meat, oil and coal, and steel -- consumption in China has already eclipsed that of the United States in all but oil. China has opened a wide lead with grain: 382 million tons to 278 million tons for the United States last year. Among the big three grains, the world's most populous country leads in the consumption of both wheat and rice, and trails the United States only in corn use.

This huge increase in consumption levels for raw materials, basic resources and commodities is also happening in India, Brazil and other emerging markets in South and Central America and in Thailand, Vietnam, Cambodia, Laos and South East Asia and Asia as their increasingly affluent middle classes aspire to the consumerist lifestyle embraced by the citizens of the 'First World'.

Currencies

The U.S. Dollar index gained 0.31 points to 82.12 on Friday and is higher by 0.65 points or 0.8% on the week.

Weaker against the dollar were the Euro which was down 1.11% for the week to $133.04. The yen was lower by 0.8 points or 0.83% on the week. The Polish Zloty, Slovakia Koruna, and South African Rand all declined 3% and the Hungarian Forint, Czech Koruna, and Romania Leu declined 2%. The greenback was up 0.2 percent against its British counterpart, with one pound worth $1.9204.

Stronger against the dollar were the commodity currencies.
The New Zealand Dollar gained 0.7%, the Canadian Dollar 0.3%, and Australian Dollar 0.2%.

Gains in the U.S. currency may be limited over concerns the U.S. will still fail to attract sufficient capital to offset its current account deficit. The shortfall in the current account was a record $187.9 billion in the fourth quarter, the Commerce Department said on Wednesday. The news sent the dollar down more than a cent on March 16, the only day this week it declined. Concerns about the current account deficit will affect the dollar's long term performance. The U.S. needs to attract more than $2 billion a day in investments from abroad to compensate for the deficit and hold the dollar's value and keep interest rates down.

Bonds

The 10-Year Treasury note yield climbed back above 4.5% Friday and gained 0.041 points to 4.511% as the March 2005 US Treasury bond lost 12/32 to 111 17/32. For the week, the yield is lower by 0.53% and the bond is higher by 0.11%.

As one of Wall Street's biggest issuers of bonds, GM's ability to recover from its problems will be severely tested by a junk rating that would increase debt costs and make any future refinancing more costly and harder to find. GM and GMAC had about $300 billion combined in debt outstanding at the end of 2004. A fall to junk status for this bond-market behemoth could have far-reaching implications for the nearly $5 trillion corporate bond market. Many insurance and pension funds are prohibited from investing in junk bonds.

GM's Soaring Bond Yields May Hurt US Corporate Borrowers and U.S. companies are likely to pay more to borrow relative to U.S. government debt after General Motors Corp.'s forecast of a loss this quarter. Automakers' bonds also play prominently in broad corporate-bond indexes. The announcement sparked the biggest weekly decline in corporate bonds since 2003 as investors pared their holdings of riskier assets in favor of U.S. Treasuries.

The Financial Times in an article entitled 'Is this the end of the road for credit?' said that "General Motors' profit warning rattled confidence in the corporate bond market this week. And with government bond yields on the rise, the credit cycle could be about to turn, ending a rally that started nearly three years ago." They also quoted Christophe Boulanger, financial analyst at Dresdner Kleinwort Wasserstein - "Given the fact that two agencies are now rating GM at the borderline of sub-investment grade, we expect forced selling to weigh on GM's valuations."

Stocks

For the week, the Dow Jones industrial average was down 1.34% to 10,628.7. On a weekly basis the Standard & Poor's 500 Index was also down 0.87%, to 1,189.65 and the Nasdaq closed at 2007.8 down 1.66%. The Nasdaq briefly dipped below the psychologically important 2000 mark and closed below it's 200 moving day average and at it's lowest level of the year so far. Some analysts believe the Nasdaq's recent underperformance and failure to hit new highs like the DOW and S&P is a sign of equity weakness or what is termed a 'bearish non-confirmation'. For the calendar year so far the DOW, S+P and Nasdaq are down 1.44%, 1.88% and 7.7% respectively.

The stock markets poor showing for the week was contributed to primarily by the continuing rise in the price of oil and on General Motor's announcement that it had lost $1.50 per share last quarter and warning of a 80% drop in profits citing sliding market share and rising costs for health care and materials. The share price dropped to $28.62 on Friday down from $34.30 at the open on Monday for a drop of some 20% for the week.

Also the share action of two other important bell weather stocks Federal National Mortgage Association or Fannie Mae (FNM), the largest mortgage finance company in the world and the second largest financial company after Citicorp, and American International Group (AIG), the world's largest insurer, was very poor.

There are regulatory probes into unusual and possibly illegal insurance contracts and signed by AIG in 2000 and 2001 and more importantly an investigation into whether American International Group distorted its results. Hank Greenberg, the tough chief executive of almost 40 years has been forced to step down from the day-to-day running of AIG. AIG was down nearly 7% for the week.

Fannie Mae on Thursday said it will not file its annual financial report on time with securities regulators, the latest disappointment for the embattled mortgage giant as it faces federal probes into accounting problems. Fannie, in a filing with the U.S. Securities and Exchange Commission, said it has not completed financial statements for 2004. FNM was down some 4% for the week and down some 45% for the last 6 months.

General Motors bonds, The Wall Street Journal reported, have moved one step closer to junk status and the share price dropped to $28.62 on Friday down from $34.30 at the open on Monday for a drop of some 20% for the week.

Incidentally the large drop in the value of General Motors leaves it at a price level which it first reached in 1963 when the Dow Jones Industrial Average was at 750. Gm was once the world's largest company and there is an old saying on Wall Street - as goes GM, so goes the Dow or "What's good for America is good for General Motors and vice versa," as former GM president Charles Wilson used to say during better times in Detroit.

The ramifications of this are important and there is even speculation among traders that GM's woes could convince the Federal Reserve to hike the Federal Funds rate at a slower pace or to stop at a lower level. (For more on this see our Bond section above).

GM's woes are not company-specific as other companies share in the problems hurting GM with large debts, massive outstanding liabilities and massive derivative hedge books.

Astute market watchers have been warning of the possible bankruptcy of GM for some time but as per a lot of outstanding financial issues today, much of the media fails to address the issue until after the fact and after the stock plunges. Financial journalists, commentators and experts who have previously called people who voice valid concerns 'alarmist' often suddenly become wise after the fact.

GM is the world's largest carmaker. It has $300 billion in debt and a market cap now of only $16 billion.
It's debt is more than 18 times it's market value - a case of negative equity if ever there was one.
Most would assume that like LTCM, Enron, Global Crossing and WorldCom, GM is "too big too fail".
We hope this is the case as a $300 billion default would be bigger than the combined losses incurred in the bankruptcy of WorldCom ($104 billion), Enron ($63 billion), Conseco ($61 billion), Global Crossing ($25 billion), United Airlines ($35 billion) and Adelphia Communications ($24 billion).

Quotes of the Week

"Oil is no longer in plentiful supply. The time when we could count on cheap oil and even cheaper natural gas is clearly ending,"
David O'Reilly Chevron Texaco Chairman, said in a recent speech

"The well-being of advanced nations presumes a smoothly operating global economy. We take this for granted without knowing whether it will always be true. We don't ask hard questions because we don't know the answers and fear what they might be."
Robert Samuelson, Economics Columnist, Newsweek

"The greenback's fall is stoking fears of a global crisis. Behind the slide: a world economy wildly out of balance.

The world economy can't get along without our massive trade deficits - and perhaps can't get along with them, either. Americans' consumption binge is propping up global trade and employment, but it's also threatening a financial upheaval that could hurt global trade and employment.What's especially unnerving is that no one knows how to disarm the dilemma. If you think that some economist - or even Alan Greenspan - has a realistic solution, think again. We've entered an unmapped forest; no one has been here before. "We've never had the leading economic power with [such an international] debt," says economic historian Barry Eichengreen of the University of California, Berkeley. The longer our huge trade deficits continue, the stronger the underlying financial pressures become... "The problem is that too many countries are required to prop up the United States," says Desmond Lachman of the American Enterprise Institute. Even if Asians buy dollars, other government central banks (their equivalent of the Federal Reserve) might sell. Or they might simply stop buying more dollars. The present U.S. current-account deficit means that foreigners have to increase their dollar holdings by almost $2 billion a day. A recent survey by Central Banking Publications of 65 central banks - apparently not including the Bank of Japan or the People's Bank of China - found that two thirds were moving away from dollars toward euros. Private investors could also desert the dollar. Indeed, it's vulnerable to almost any unpleasant surprise. Consider what happened in late February when the Bank of Korea said it might shift foreign-exchange reserves away from the dollar. Not only did the dollar fall, but the Dow dropped 174 points. That's precisely the sort of chain reaction many economists fear...

The result is a global political stalemate that perpetuates a pattern of world economic growth that might one day be highly damaging to all of us... The real issue is whether the present pattern of global economic growth is inherently unstable - and whether it can be easily corrected. America's huge and expanding trade deficits have served as a narcotic for the rest of the world. As with all narcotics, resulting highs have been artificial and, to some extent, delusional to both the dealer and the addicts. The question now is whether everyone can go straight, before the addiction becomes self-destructive. It is whether the Asians can curb their export dependence; whether the Europeans can revitalize their economies; whether the Americans can control their overconsumption. The dollar's fluctuations and frailties are mainly the outward manifestations of this larger predicament. To paraphrase former Treasury Secretary John Connally: the dollar may be America's currency, but it's the world's problem.
Robert Samuelson, Economics Columnist, Newsweek

"At Moody's we spend a great deal of time studying the issue of pension burdens for countries around the world. It is clear to us that rapidly aging populations in the industrialized world, as well as in certain emerging market countries, will pose some complicated economic and financial problems going forward. First, when examining the various industrialized countries, what we have concluded at Moody's is that almost every country will "default" on its pensions."
Vincent Truglia, Managing Director of the Sovereign Risk Unit, Moody's Investor Services testifying to the House Ways and Means Committee

"The dollar's value and status as reserve currency cannot forever stand the trade and budget deficits that are now part and parcel of America's economic policy. Unless there are major changes soon, America's economic future is a third world work force with a banana democracy's worthless currency."
Paul Craig Roberts, Former Assistant Secretary of the Treasury in the Reagan Administration and Associate Editor of the Wall Street Journal editorial page.

"Ultimately, the U.S. government will either repay its debts or default on them. We need only look at the Argentine debt crisis of 2001 for an example of what happens when a government fails to make even minimum payments to creditors. The Argentine economy virtually collapsed, and the value of her money tumbled. This is something most Americans cannot fathom, especially a political class that mistakenly thinks it can't happen here."
Dr. Ron Paul, U.S. Congressman, Member of the House Financial Services Committee

"All over the world, new bonds of trade and strategic cooperation are being forged around the U.S.. China has not only begun to displace the U.S. as the dominant player in the Asia Pacific Economic Cooperation organization (APEC), it is fast emerging as the major trading partner to some of Latin America's largest economies. . . French foreign policy think tanks have long promoted the goal of 'multipolarity' in a post-Cold War world, i.e., the preference for many different, competing power centers rather than the 'unipolarity' of the U.S. as a single hyper-power. Multipolarity is no longer simply a strategic goal. It is an emerging reality."
Tony Karon, Time Magazine

"But the Faustian deal into which Bretton Woods II has turned - whereby America gets to spend beyond its means and Asia gets to invest in export-led growth, at the cost of recycling much of its earnings in America's securities markets - turns out to have a shorter horizon than most people reckoned. It could turn sour at any time now... Russia, Indonesia, South Korea, India and Japan have all murmured significantly, if guardedly, about diversifying of late. Though figures are elusive, the best guess is that most are doing so already. At the end of February, officials and academics from all around Asia met in Bangkok to discuss the sliding dollar and concluded that they should move more definitively to their own advantage. There are repeated suggestions that regional payments systems should be set up, such as the gold dinar standard suggested for the Islamic world in 2002 by Malaysia's prime minister. It is possible that, this time around, OPEC and other oil exporters will channel their windfall profits through the Treasury's books. But what will happen if a significant portion of countries decided not to add to their dollar holdings? More than the dollar would weaken. Big foreign buyers of bonds have been keeping interest rates down, perhaps by one percentage point, as Alan Greenspan suggests. That would change, for a start. Without this support, the yield on the ten-year benchmark Treasury bond could rise to more than 5%, pushing up interest rates on mortgages. That, in turn, could prick America's house-price bubble and prompt a general deleveraging, with implications for economic growth both in America and elsewhere. Standard & Poor's, a rating agency, warned on Monday that a weak dollar would substantially increase concerns about credit quality. This is perhaps not the week to air such apocalyptic concerns, though they are much on Buttonwood's mind. In the end, what foreign central bankers have it in their power to do is to reveal before all the world that the mighty American economic empire has no clothes."
Buttonwood, The Economist

"Given the dollar's role as a currency of last resort, some wonder if its decline heralds not just an economic adjustment by the United States, but a crisis of sorts in the value of paper money itself. Money in its present form is a relatively new invention. For most of human history money meant either gold or silver, either directly, or indirectly by means of the "gold standard" which meant, at least in theory, that all paper money was backed by gold. Enthusiasm for the gold standard evaporated in the 1930s, when it made dreadful conditions worse. But it was adopted in a watered-down version after the second world war, when only the dollar was backed by gold. This arrangement made some sense, since America held three-quarters of the world's gold stock. But it came to an end in 1971, when inflationary pressures in America caused the country's manufacturers to become uncompetitive and forced the country off the gold standard. Since then the world has relied on "fiat money", so-called because it is created by government fiat and is backed only by the promises of central bankers to protect the value of their currencies. It is the value of those promises that some are now questioning... Fans of gold - known as gold bugs - wonder whether those promises are worth the paper they aren't written on... Certainly, those promises have only been worth much in recent years. In the early years of fiat money, inflation took off, especially in America, in part because of the two oil shocks of the 1970s. This debased the value of the dollar, and the price of gold climbed from $35 an ounce to $850."
Buttonwood, The Economist

"In 1913, at the height of its empire, Britain was the world's biggest creditor. Within 40 years, after two costly world wars and economic mismanagement, it became a net debtor and the dollar usurped sterling's role. Dislodging an incumbent currency can take years. Sterling maintained a central international role for at least half a century after America's GDP overtook Britain's at the end of the 19th century. But it did eventually lose that status.

If America continues on its current profligate path, the dollar is likely to suffer a similar fate. But in future no one currency, such as the euro, is likely to take over. Instead, the world might drift towards a multiple reserve-currency system shared among the dollar, the euro and the yen (or indeed the yuan at some time in the future). That still implies a big drop in the long-term share of dollar assets in central banks' vaults and private portfolios. A slow, steady shift out of dollars could perhaps be handled. But if America continues to show such neglect of its own currency, then a fast-falling dollar and rising American interest rates would result. It will be how far and how fast the dollar falls that determines the future for America's economy and the world's."
Editorial, The Economist 

"Tipping points are a great concept, but virtually impossible to identify ahead of time -- let alone when they are occurring. It is only with the great luxury of hindsight that we can look back and know that the proverbial bell has rung. In my view, March 16, 2005 could end up in the running as a possible tipping point for America. Suddenly, the US has taken on a very different aura in an increasingly unbalanced world: The confluence of a record current account deficit, a disaster from General Motors, and yet another new high for oil prices all speak of an increasingly precarious role for the global hegemon. World financial markets have barely begun to sniff that out. The current account deficit probably says it all. As I have noted ad nauseum, it is an outgrowth of America's biggest problem -- an unprecedented shortfall of national saving... In the end, of course, there's far more to this story than economics. As I noted recently, history is replete with examples of leadership tests that pit a nation's military prowess against its economic base (see my 28 February dispatch, "The Pendulum of Global Leadership"). Yale historian Paul Kennedy has long argued that great powers typically fail when military reach outstrips a nation's economic strength. In that vein, there's little doubt that America is extending its reach in this post-9/11 world. Wars in Afghanistan and Iraq were the opening salvos. The Bush Administration's recent nomination of two leading neocons to key global positions -- John Bolton as America's ambassador to the UN and Paul Wolfowitz to head the World Bank (also announced on March 16) -- are more recent examples of a White House that is upping the ante on its "transformational" projection of global power. In Paul Kennedy's historical framework, America is extending its reach at precisely the moment when its economic power base is weakening -- a classic warning sign of the fall of a Great Power.

Was March 16, 2005 America's tipping point? Only time will tell. The optimist can hope that it was a wake-up call for a saving-short US economy to put its house back in order. For once, call me an optimist. It's time for America to smell the coffee."
Stephen Roach, Chief Economist, Morgan Stanley

"The possibility of a liquidity bubble around the world concerns me. A very cautionary thing is that it feels like the world is changing and traditional indices may not give a complete picture."
Chuck Prince, Chief Executive, Citigroup

Key Events in the Week Ahead

On Tuesday, March 22, the Federal Reserve Open Market Committee meets to decide whether to raise, lower or hold steady the target federal funds rate, which is the rate at which banks make overnight loans to each other. The consensus is that the Fed will push up the target by a quarter of a percentage point to 2.75 percent, the seventh increase since the summer of 2003. A handful of bond traders a bump of half a percentage point. For more on why the Fed could become more aggressive.

Tuesday sees the release of the PPI
Wednesday sees the release of the CPI. Both should give some indication of whether inflation is picking up in the US economy.
On Thursday the Order for Durable Goods (big-ticket manufactured items expected to last at least three years) number for February is released. It dropped 0.9% for the month of January.