Category Archives: 3 The World of Money

Commodity prices underpin inflation

Many observers have noted the spike in food commodity prices, underpinned by interest in corn for ethanol in the US.  There also appears to be a broader rise in prices of commodities which is bound to push up inflation.  Last year the pressure on metal commodities from demand from China was observed.  As the chart from Reserve Bank of Australia shows, commodity prices have spiked as prices for metals and food are now rising.  Their index is at an all time high and the index chart for the past couple of years is vertiginous.

While central bankers and regulators scramble to be seen to do something about the stagnation of financial markets, I do not think that interest rate reductions are going to help.  In fact they may exacerbate problems as they contribute to the moral hazard of investors believing there is no downside and contribute to the difficulty of ascertaining the balance of economic conditions because of unnecessary changes in monetary and fiscal policy.

Cost of food rising fast, driving inflation and hurting the poor

rural commodity pricesThe cost of food is rising fast. We had been expecting this because of variations in weather patterns which we feared would upset cultivation. However, the sudden interest in corn for ethanol, since the warnings last year by the Stern Review, An Inconvenient Truth and IPCC, has also contributed to an increase. The chart here shows the Reserve Bank of Australia’s index for food commodities since 1982. (Includes Wheat, Beef and veal, Wool, Cotton, Sugar, Barley, Canola, Rice.) It is now at its highest level ever, having bounced up in the past couple of months.

While we will start to feel the pinch at the basic end of our consumption spectrum and this relative scarcity of food commodities will push up inflation, it is the poor of the world that will suffer most, particularly the poor in developing countries. The first sign of this pain was the hike in corn prices in the middle of the year as agro-industrial giants and investors rushed to invest in US corn for ethanol, which meant Mexican’s staple tortilla doubled in price. Now signs of a wider pain are showing as we learn that US food aid has halved because of increasing prices: The amount of food bought for American food aid programs has fallen to 2.4 million metric tons this year from 4 million metric tons in 2005 and 5.3 million metric tons in 2000.

It is perhaps time to think more seriously of ending the food subsidies that rich countries pay their farmers. That would have the multiple benefits of moderating prices of commodities, helping feed people in poor countries and realigning resource use to a more natural and economical profile in rich countries.

(Further browsing: the UN Food and Agriculture Organisation (many divisions, lots of news and data) USDA Food sector site and an interesting site on food history.

APEC for climate change and trade

The principal messages from leaders meeting at the APEC summit recently concluded in Sydney Australia are to prioritise action to reduce climate change and to successfully conclude the WTO Doha round trade talks.

These are entirely appropriate prime objectives.  Unfortunately, the US, which is the largest per capita carbon emitter and world superpower, and Australia, host to the meetings, are both laggards in addressing climate change.  And although talks in Geneva continue in an attempt to resolve the deadlock on trade and subsidies, there is little sign or hope that progress will be made as long as America, Japan, EU and others continue to protect their markets.

Unfortunately the statements appear to be more self-serving propaganda to support incumbent administrations rather than underpinning new initiative.  There will be more time wasted on talks, while the biosphere’s volatility rises and emerging economies are locked out of the capitalist club by protectionist policies.

Should you invest in the company or its management … ?

A 2004 study, recently updated, adds to the debate about whether management or the company is the important focus of investment screening.  The study, written by Steve Kaplan of the University of Chicago, Berk Sensoy of USC and Per Stromberg of SIFR, found that over 90% of successful VC-backed companies have the same business model at the time of IPO as they had at the time of initial VC funding. Conversely, only 72% have the same CEO, and that number drops to 44% by the third annual report. Interestingly, the researchers also examined a sample that included both VC-backed and non-VC backed IPOs for 2004, and found no demonstrable difference in the human variable’s importance.

You might question the sustainable value of management, however, the results may be a bit sterile and simply reflect the effecient evolution of business aided by experienced VCs.  As a company grows from early stage to a self-sustaining critical mass, the nature changes from entrepreneurial and adds other dimensions.  This requires a changing culture of management, which often requires new skills at the top which may not be displayed by the founder or (incumbent CEO).

While we think management is critical to the success of VC investment, it is also certain that if the company is in the wrong business, because the market is not ready or passed, then even the best CEO won’t make the numbers.

US August data modest

Retail sales and industrial output both slowed in the US in August.

Shop sales grew 0.3% in August, below market expectations of a 0.5% rise and below July’s 0.5% increase, but excluding car sales, which are at their strongest in two years, retail spending actually declined 0.4% in August.

Industrial output rose 0.2%, the slowest pace in the past three months; output at U.S. factories fell 0.3% last month, the first decline in manufacturing after five straight increases.

Last month the economy also shed 4,000 jobs. The August figure from the Department of Labor came as a surprise, because economists had anticipated data showing an increase of 110,000 jobs. The last time the US economy shed jobs was four years ago in August 2003 when the total number employed fell by 42,000. The Department of Labor also cut its estimates for the number of new employees hired in June and July by a total of 81,000.

Meanwhile, figures from the University of Michigan showed that consumer confidence remains close to a yearly low.

A piece of more positive economic news: the US balance of payments deficit, which has been a factor in the weakness of the dollar, narrowed to $190.8 billion in the second quarter from $197.1 billion in the previous three months. However, this may be partly a consequence of a slowing economy and more expensive imports. The financial system is working.

We expect data to continue to be modest, but this is appropriate and will equalise the imbalances in the US economy, allowing a natural adjustment there and globally. Importantly, these changes must be underpinned by a changing culture, one which saves more and spends on infrastructure, health and education as much as convenience consumption.

Sub-prime losses estimates rising

Fed Chairman said during testimony to the the House Committee on Financial Services on 20 September that losses from sub-prime mortgages have far exceeded “even the most pessimistic estimates”. This statement is disappointing because it undermines any build-up of confidence that might be encouraged by recent rate cuts and liquidity injections.

But worse, his comments do not quantify the Fed’s understanding of the losses. We shared an estimate of sub-prime exposure of $ 250 billion some months ago, although most analysts estimates are closer to $ 100 billion. If the exposure exceeds even our pessimistic number, the knock-on effect will be devastating; if, however, it exceeds the previous consensus the ramifications are already accounted for.

Whatever the number is, the adjustment process must continue for some months yet.

Hype over Chinese toys exaggerated

Recent hype about problems with Chinese manufactured goods was used as an excuse by some protectionist politicians and lobbies in the US to push for trade sanctions and even used as a tool to push for revaluation of the Chinese renminbi. The greatest hype surrounded the recall of more than 20 million toys by Mattel. However, Mattel now has admitted that most of the toys recalled in recent safety scares had “design flaws” and that Chinese manufacturers were not to blame!

This is not surprising in light of the story we related in August Review about Bush ignoring the toxic off-gassing results of a Mattel doll that were shared with him by Michael Braungart 3 years ago.  And perhaps more revealing is the declaration that China is simply following good capitalist practice (role-modeled by the US of course) by using lead paint because its cheaper!

A senior Mattel executive apologised for the damage that the incidents had done to the reputation of Chinese-made goods. Too little too late, perhaps. Mattel needs to make a public apology in the US, and the general tone of belligerence that the US employs on all “partners” needs to be softened as America grows up.

Chinese rates up again, but inflation still an issue

China’s central bank increased rates for the fifth time this year. The one year lending rate is now 7.29% as authorities attempt to ease inflationary pressure. However, the build-up of reserves continues as those that can borrow US$ at under 5%, like multinationals and foreign investors, do.  The discrepancy between interest rates net of currency appreciation, fuels a carry-trade.

Their other tactic has been to ease investment control allowing investment outside China, which offers some pressure relief valve for money to find its way out of China.  This is unlikely to be sufficient however to moderate inflation.  This is therefore going to add to pressure for teh Yuan to appreciate.  While the Chinese authorities may accelerate that appreciation they are very unlikely to pursue destabilising step changes in the currency that American and European authorities have been calling for.

The financial market risk of climate change

We’ve mentioned it before – people are getting together with lawyers to focus on polluters in the same way cigarette makers were targeted.

On the same day that US rates were lowered investors and NGOs petitioned the SEC to clarify whether firms had an obligation to disclose how climate change might affect them.  It is certain that disclosure must occur.  Directors ought to know since it is a significant material business risk, and if they know shareholders must too.

Mishkin’s band-aid

Will the interest rate cut be seen as prescient salvation or impulsive band-aid in the coming months? The Fed, it seems, were swayed by Frederic Mishkin who, notes The Economist,

argued forcefully in a recent speech that central bankers can cushion the impact of falling house prices on the economy, provided they act quickly and decisively, at little cost in terms of inflation.

While the markets bounced quickly it is not certain to be sustained and much can happen in the coming months. Let’s hope for stability, though our track record is not good and I can’t help remembering that Enron hired The Smartest Guys in The Room. We shall watch markets and data in the coming weeks to see where the pressure bears (ha ha).

As always, screening should be selective. Prefer fundamentals to story.

Further reading: An essay by The Economist discussing the Fed’s policy approach.