FuturesAsia

Blame the Fed for the Financial Crisis

2011-10-24T19:10:00.000-07:00

The Fed fails to grasp that an interest rate is a price, the price of time. Attempting to manipulate that price is as destructive as any other government price control.

By RON PAUL

OCTOBER 20, 2011 — To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price fixing, which leads not to prosperity but to disaster.

The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

Eventually, the economic boom created by the Fed's actions is found to be unsustainable, and the bust ensues as this malinvested capital manifests itself in a surplus of capital goods, inventory overhangs, etc. Until these misdirected resources are put to a more productive use—the uses the free market actually desires—the economy stagnates.

The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. What the Austrian economists Ludwig von Mises and Friedrich von Hayek victoriously asserted in the socialist calculation debate of the 1920s and 1930s—the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed's monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed's actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market's neck.

The Fed's quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

What exactly the Fed will do is anyone's guess, and it is no surprise that markets continue to founder as anticipation mounts. If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free.

Mr. Paul, a congressman from Texas, is seeking the Republican presidential nomination.

Risk on the rise as political leaders give in to mob rule

2011-10-24T17:45:00.000-07:00

By Ray Dalio

FT -- We are in the midst of a deleveraging, we are nearly out of ammunition and we are at each other’s throats. Being in a deleveraging and nearly out of ammunition is a very difficult position to be in. But, being at each other’s throats is our biggest problem.

Our character and our political and social systems are now being tested in ways that have typically been tested in past deleveragings. In deleveragings bad economic conditions typically lead to emotional reactions, social and political fragmentation, poor decision-making and increased conflict. When this occurs in democracies, the checks and balance system, which is intended to yield the best decisions for the whole, can stand in the way of thoughtful leadership and lead to ineffective “mob” rule. This dynamic can lead to a self-reinforcing downward spiral.

Frustrations increase, the established ways of doing things come under attack and frustrations over the ineffectiveness of government creates the perceived need for someone to gain control of the mess. Plato spoke of this dynamic. It was the reason Hitler was elected in 1933.

In our opinion these types of risks are now emerging and should be taken into consideration when trying to figure out what may lie ahead. Rather than trying to resolve disagreements through thoughtful discourse, people are now trying to grab power to beat and suppress their opponents. Tensions between the rich and the poor, capitalists and socialists, those in and out of power and different factions in each group are now intensifying in a manner that is classic in deleveragings. Politicians who are fighting for power in a political year are fanning the flames and are increasingly willing to do risky things (like shutting down the government) in pursuit of their missions and popular support.
This growing populism will have important implications for monetary, fiscal and trade policies and will significantly increase risks of a markets downturn and a global depression.

Regarding monetary policy, the mob is at the gates of the Federal Reserve and wants to grab control while those on the inside are in disagreement about what should be done. Fed chairman Ben Bernanke and those who helped him save the country from depression are now under siege. These challenges are being faced in different forms by most central banks at the same time as they are nearly out of ammunition – i.e., their capacities to ease are very limited because they cannot stimulate private credit creation and because they cannot get money in the hands of people who will spend it. For these reasons there is greater risk that central banks cannot save us as they have always saved us in the past.

The battle between the left that wants to tax the rich more and the right that wants to cut entitlement spending is at a fierce stalemate that is likely to intensify in more scary ways. As a result, fiscal policy is unlikely to be supportive to economic growth.

With high unemployment and growing anger, the “mob” is blaming the foreigners who “took their jobs,” especially the Chinese who they say are “manipulating” their currency to “compete unfairly”. And since politicians want popular support, they are navigating this issue to gain political benefit (e.g., to put the US President in the position of having to choose between the political suicide of vetoing Senator Charles Schumer’s currency bill and clashing with China) rather than to approach this difficult issue calmly and analytically. Trade flows and capital flows are increasingly being looked at by all sides as possible weapons in an economic war. As a result, the risks of bad surprises in trade and capital flows are heightened.

Mobs are at the doors of bankers and others in the financial system, screaming to politicians to put these people in jail while the vote-seeking politicians are fanning the flames rather than reminding people that the legal system is the way these people should be judged. Since banks are levered about 15 to 1, it doesn’t take much of a debt problem to cause them solvency problems, and since in deleveragings debt problems are big, there is significant risk banks will run out of equity again and the fury against them will intensify. For these reasons risks to the global banking system are much greater than normal.

While we hope that most people and their leaders will approach these difficult challenges calmly and collectively, we would not be meeting our fiduciary responsibilities if we bet on this happening without clear evidence of it. We are not alone in having and expressing our concerns in what has come to be known as “risk-on” and “risk-off” market movements.
If we calm down and work together to properly manage this difficult situation – for example, if we can properly distribute both the austerity and the increased efforts that are required to manage our debt burdens – we can get through this deleveraging without great pain. If we can’t, we may experience an economic, social and political collapse.

Ray Dalio is founder of Bridgewater Associates

Commodity traders: The trillion dollar club

2011-10-22T00:50:00.001-07:00

By Joshua Schneyer

Friday October 21, 2011

NEW YORK (Reuters)- For the small club of companies who trade the food, fuels and metals that keep the world running, the last decade has been sensational. Driven by the rise of Brazil, China, India and other fast-growing economies, the global commodities boom has turbocharged profits at the world's biggest trading houses.

They form an exclusive group, whose loosely regulated members are often based in such tax havens as Switzerland. Together, they are worth over a trillion dollars in annual revenue and control more than half the world's freely traded commodities. The top five piled up $629 billion in revenues last year, just below the global top five financial companies and more than the combined sales of leading players in tech or telecoms. Many amass speculative positions worth billions in raw goods, or hoard commodities in warehouses and super-tankers during periods of tight supply.

U.S. and European regulators are cracking down on big banks and hedge funds that speculate in raw goods, but trading firms remain largely untouched. Many are unlisted or family run, and because they trade physical goods are largely impervious to financial regulators. Outside the commodities business, many of these quiet giants who broker the world's basic goods are little known.

Their reach is expanding. Big trading firms now own a growing number of the mines that produce many of our commodities, the ships and pipelines that carry them, and the warehouses, silos and ports where they are stored. With their connections and inside knowledge -- commodities markets are mostly free of insider-trading restrictions -- trading houses have become power brokers, especially in fast-developing Asia, Latin America and Africa. They are part of the food chain, yet help shape it, and the personal rewards can be huge. "The payout percentage of profits at the commodities houses can be double what Wall Street banks pay," says George Stein of New York headhunting firm Commodity Talent.

Switzerland-based Glencore, whose initial public offering (IPO) in May put trading houses in the spotlight, pays some traders yearly bonuses in the tens of millions. On paper, the partial float made boss Ivan Glasenberg $10 billion richer overnight.

SIZE MATTERS

How big are the biggest trading houses? Put it this way: two of them, Vitol and Trafigura, sold a combined 8.1 million barrels a day of oil last year. That's equal to the combined oil exports of Saudi Arabia and Venezuela.

Or this: Glencore in 2010 controlled 55 percent of the world's traded zinc market, and 36 percent of that for copper.

Or this: publicity-shy Vitol's sales of $195 billion in 2010 were twice those at Apple Inc. As well as the 200 tankers it has at sea, Vitol owns storage tanks on five continents.

U.S. regulations are now pending to limit banks' proprietary trading -- speculating with their own cash. The new rules don't apply to trading firms. "Trading houses have huge volumes of proprietary trading. In some cases it makes up 60-80 percent of what they do," said Carl Holland, a former price risk manager at oil major Chevron Texaco, who now runs energy consultancy Trading Solutions LLC in Connecticut. "They have the most talent, the deepest pockets, and the best risk management."

In addition to proprietary trading curbs, the U.S. regulator voted on October 19 to impose position limits in oil and metals markets. That gives banks who trade futures cause for concern, but since physical players usually receive exemptions to limits -- because they are categorized as bona fide hedgers -- trading firms should go unscathed.

The trading houses' talent and deep pockets translate into incredible power. "Most commodity buyers in the world are price takers. The top trading firms are price makers," said Chris Hinde, editor of London-based Mining Journal. "It puts them in a tremendous position."

The sort of position that has allowed Vitol to do a brisk oil business with the U.S. government, the besieged Syrian regime, and Libya's newly empowered rebels simultaneously over the past few months. In April the company dodged NATO bombs and a naval blockade and sent an oil tanker into the battered Mediterranean port of Tobruk to extract the first cargo of premium crude sold by rebels at the helm of a breakaway Libyan oil company defying Muammar Gaddafi.

Vitol also discreetly supplied Libya's rebels with $1 billion in fuel, Reuters has learned -- supplies they desperately needed to advance on Tripoli. Vitol's early running gave the firm an edge with the country's new political stewards. As it turns the pumps back on, Libyan oil firm Agoco has allocated Vitol half of its crude production to repay debts.

While its savvy traders were doing deals in eastern Libya, Vitol, along with rival Trafigura, kept refined product supplies flowing to the besieged government of Bashar al-Assad in Syria as his troops attacked civilians. Trading houses were able to do this because international sanctions on Syria do not ban the sale of fuel into the country, but they did not have to fight off much competition for that business.

PAST SCRUTINY

Despite a relative lack of regulatory oversight, such reach does attract scrutiny. "There has always been some concern about the trading firms' influence," said Craig Pirrong, a finance professor and commodities specialist at the University of Houston, who points out that some firms "have been associated with allegations of market manipulation".

Public and regulatory attention usually rises with prices. A spike in world food prices in 2007 stirred an outcry against the largest grain trading firms; when oil prices surged to a record $147 a barrel in 2008, U.S. Congress probed the role of oil trading firms, but found no smoking gun. But in May the U.S. Commodity Futures Trading Commission sued Arcadia and Parnon, both owned by a Norwegian shipping billionaire, for allegedly manipulating U.S. oil prices three years ago, amassing millions of barrels they had no intention of using. The companies dispute the charges.

Some transgressions make headlines. Switzerland-based Trafigura was caught shipping sanctioned Iraqi crude in 2001, and in 2006 a tanker it chartered dumped toxic waste in Ivory Coast, allegedly making thousands ill and killing up to 16. Courts did not find any connection between its waste and sick people. But after unsuccessfully suing to keep a British parliamentary probe out of the newspapers, Trafigura paid $200 million in compensation.

And it's not just the Europeans. Executives of Illinois-based ADM, formerly Archer Daniels Midland, were jailed for an early 1990s international price-fixing conspiracy for animal feed additive lysine. After Minnesota-based Cargill built a huge soybean terminal on the banks of the Amazon River in 2003, it was targeted by Greenpeace and subjected to Brazilian government injunctions for allegedly encouraging more farming in fragile rainforest. Cargill has since placed a moratorium on buying soybeans from newly deforested land.

THE SQUEEZE AND THE ARB

For many commodities traders, the most profitable ploy has been the squeeze, which involves driving prices up or down by accumulating a dominant position. In the early 2000s, the Brent crude oil stream -- used as a global price benchmark -- fell to 400,000 barrels per day from more than 1 million in the late 1980s. A few traders seized the chance to buy what amounted to almost all the available supply. Price premiums for immediate supply spiked, sapping margins for refiners worldwide. U.S. refiner Tosco sued Arcadia and Glencore for market manipulation; the case was settled out of court.

In metals, stock in warehouses can be tied up for years as loan collateral, allowing the same traders who dominate the metals market to control a huge chunk of world supply -- an apparent conflict of interest that has drawn criticism from the UK parliament.

"The warehouses seem to have an infinite capacity to absorb metal, but a very small capacity to release it," said Nick Madden of Novelis, the world's top rolled aluminum producer.

Trading houses saw the opportunity to leverage metals warehousing after the 2008 financial crisis. Of the six major metals warehousers only one, Dutch-based C.Steinweg, remains independent. Trading houses competed with banks for the spoils -- Glencore, Trafigura and Noble took one warehousing company each, Goldman and JP Morgan the others.

And unlike commodities producers, such as U.S. oil giant Exxon Mobil, trading firms don't just make money when prices go up. Most rely on arbitrage -- playing the divergence in prices at different locations, between different future delivery dates, or between a commodity's quality in different places.

That's what Koch, Vitol and others did in 2009 when they parked 100 million barrels of oil in seaborne tankers. Thanks to a market condition known as contango -- a period when buyers pay more for future delivery than to receive their cargoes promptly -- they could sell futures and lock in profits of $10 a barrel or more.

RICH HISTORY

Many of the biggest players in oil and metals trading trace their roots back to notorious trader Marc Rich, whose triumph in the 1960s and 70s was to create a spot market for oil, wresting business away from the majors.

Belgium-born Rich joined Philipp Brothers, subsequently Phibro, aged 20, leaving in 1974 with a fellow graduate of the Phibro mailroom, Pincus "Pinky" Green, to set up Marc Rich and Co AG in Switzerland.

Rich, now 76, would later end up on the FBI's most-wanted list for alleged tax evasion and trading oil from Iran after the revolution in 1979. He was later pardoned. His partners seized control of the firm in 1994, renaming it Glencore.

Several big trading houses are still family-held -- firms like agricultural giant Cargill, the top private U.S. company, or Kansas-based Koch Industries, a close No. 2. Koch's chief executive Charles Koch, a libertarian activist with a $22 billion personal fortune according to Forbes, has said his company would go public "over my dead body". "The thinking is, why open the books to the world?" said a former lobbyist for Koch who requested anonymity. "Koch benefits from privacy, and it's astonishingly agile and profitable as is."

The old guard now faces a challenge from a new breed of Asian competitors. Companies like Hong Kong-based Noble and Singapore's Olam and Hin Leong are not new, but they are spreading their wings as China's influence in commodities markets increases. Chinese state funds have flowed into Noble and private Asian traders. As China's clout grows, it's very likely that Chinese firms will build trading dynasties of their own. In a move borrowed from the playbooks of western rivals, state-run oil firm PetroChina has set up a Houston oil trading desk and leased massive oil storage tanks in the Caribbean. "China is becoming more like a Glencore," said Hinde. "The Chinese state is funding nimble trading firms to do its bidding. We don't hear much about them yet, but in time we will."

Here's a look at the 16 companies, with aggregate revenues of $1.1 trillion, that trade energy, metals and agriculture.

SAILING CLOSE TO THE WIND

WHO: Vitol, founded 1966 in Rotterdam by Henk Vietor and Jacques Detiger WHERE: Geneva and Rotterdam WHAT: Oil, gas, power, coal, industrial metals, sugar TURNOVER: $195 billion (2010) CEO: Ian Taylor STAFF: 2,700

By Richard Mably

On the world oil markets the name Vitol is as familiar as Exxon is at the petrol pump.

In public, for a company that turned over almost $200 billion last year trading 5.5 million barrels a day, its profile is nigh on subterranean.

But earlier this year the world's wealthiest oil trader raised that profile, and did its reputation no harm, by becoming the first to deal with Libya's rebels, long before the overthrow of Muammar Gaddafi.

That helped balance the reputational damage of being fined -- along with many other companies -- for paying surcharges a decade ago to Saddam Hussein's Iraqi oil ministry during the U.N. oil-for-food program.

Vitol's Saddam connection does not seem to have hurt it in Iraq. It became the first company to supply gasoline to the energy ministry after the war in 2003, and now is both a buyer of Iraqi crude and supplier of refined products.

An array of storage tanks on five continents oils the wheels of its vast trading operation and it has stepped into the gap left by the oil majors as they reduce their downstream presence to focus on upstream exploration and production.

With African investors Helios Investment it recently paid a billion dollars to buy Shell's fuel marketing operation across 14 West African countries, keeping the Shell branding.

It has also dipped a toe in the upstream business. Together with Glencore, it pre-qualified to bid for exploration rights in Iraq in a licensing round next year that that could add the Iraqi upstream to its offshore West Africa operations.

Its early dealings with the Libyan rebels may offer the chance of a foothold in Libya's oil and gas territory.

"Vitol's goal was to supply the refined products and then try to pick up upstream assets in Libya," said a western diplomatic source.

Glencore's flotation has sparked speculation about a possible Vitol initial public offering and what it would be worth. Vitol says it is happy with its private status and has no IPO plans.

By annual revenue Vitol is richer than Glencore but the numbers aren't directly comparable -- Glencore owns more hard assets which, typically, are far more profitable than trade turnover.

Vitol's wealth is spread across only 330 share-holding employees, fewer than Glencore's 500. While Vitol would not comment, industry talk has it that none of its senior employees, including CEO Ian Taylor who joined from Shell in 1985 or long-timer Bob Finch who heads Vitol's coal business, holds more than 5 percent of the company. That would put them well below the 16 percent stake Glencore CEO Ivan Glasenberg owns in his firm.

The company's deal with Libya's rebels was a gamble. Sanctions targeted Gaddafi. The firms now controlled by the western-backed rebels might still legally be linked to Libya's national oil corporation. Was Vitol in violation? Lawyers said doing business with the rebels still required great care. But by the end of April, a U.S. Treasury directive authorized the Vitol transactions.

"They sail as close to the wind as they possibly can legally," said an oil analyst who requested anonymity. "That's the nature of their business."

(additional reporting Barbara Lewis)

PRIVATE TO PUBLIC

WHO: Glencore, founded 1974 as Marc Rich and Co. renamed Glencore in 1994 WHERE: Baar, Switzerland WHAT: Metals, minerals, energy, agricultural products REVENUE: $145 billion in 2010 CEO: Ivan Glasenberg STAFF: 2,800 people directly; 55,000 at Glencore's industrial assets

By Clara Ferreira Marques

Switzerland-based Glencore cast aside its famed secrecy earlier this year with a record market debut that turned its executives into paper millionaires and propelled the firm into the headlines.

Founded in 1974 by Marc Rich, who fell foul of U.S. authorities but was later pardoned by President Bill Clinton, Glencore has assets spanning the globe and an oil division with more ships than Britain's Royal Navy. Top officials in many other large trading companies began their careers at Glencore.

The company handles 3 percent of the world's daily oil consumption. It's one of the largest physical suppliers of metals including zinc, lead and nickel, and a leading grain exporter from Europe, the former Soviet Union and Australia.

Though it began as a pure metals and oil trader, Glencore has bought a wealth of industrial assets since the late 1980s which now stretches from South American farmland to copper mines in Zambia.

Belgium-born Rich sold his stake in 1994.

The company's largest shareholder is now former coal trader and Chief Executive Ivan Glasenberg, an intense and charismatic South African who holds a stake of just under 16 percent, worth around 4.5 billion pounds at current prices.

Still not entirely comfortable with his public profile, Glasenberg has described his shift into the glare of publicity as "crossing the Rubicon". He is flanked in the top investor table by the youthful heads of Glencore's major divisions. Together, Glencore employees, including many of its top traders, own just under 80 percent of the company.

Glencore has long made its fortune by working on the fringes and in areas where few others dared. That strategy has often succeeded, though last month it found itself at the center of a dispute in the newly minted nation of South Sudan. A row over oil export control could jeopardize its role in selling the nation's crude.

Glencore's initial public offering was the largest globally this year, attracting huge publicity as well as arguments that it marked the top of the commodities cycle. The shares listed at 530 pence in May but have since traded below that, dropping almost a quarter in three months.

A large part of Glencore's market value comes from its listed stakes in other companies, most notably a 34.5 percent holding in Swiss miner Xstrata. Glencore has said publicly it would see "good value" in a merger with Xstrata, but that has so far been rejected by other, smaller, shareholders.

BACK-HAUL MASTERS

WHO: Cargill, founded 1865 by William Wallace Cargill at the end of the U.S. Civil War WHERE: Minneapolis, Minnesota WHAT: Grains, oilseeds, salt, fertilizers, metals, energy TURNOVER: $108 billion (2010) CEO: Greg Page STAFF: 130,000

By Christine Stebbins

Tucked away in a private forest an hour's drive from the downtown high rises of mid-western Minnesota stands a brick mansion that strikes most visitors the same way: isolated, solid, regal, powerful.

Inside the "lake office," as it is known, sits the chairman of Cargill Inc., one of the largest privately held companies in the world.

Over the last 145 years, Cargill has grown from a single grain storage warehouse by an Iowa railroad to a behemoth of world commodities trade, straddling dozens of markets for food and other essential materials -- salt, fertilizer, metals.

With global sales of $108 billion in 2010, Cargill would have ranked No. 13 in the Fortune 500 list of publicly held companies, just behind Wall Street banking giant Citigroup.

But Cargill is anything but public. Despite a concerted campaign in recent years to put forth a friendlier face and personality through advertising and more appearances by its executives in public forums, Cargill is bound together by a culture of confidentiality, aggressiveness -- and winning.

"By and large they move as a team," says one retired wheat trader who did business with Cargill for decades. "They have some superstars but mostly a lot of team players -- what I would describe as well grounded, fundamental traders."

One of their secrets: filling the empty barges headed home.

"You've always had grain going down the river and going through the Gulf and being exported. One of the great things that Cargill did was develop the salt business to transport back up, eliminate the snow during the wintertime, and fill barges back up with back hauls," the wheat trader said.

"It was done a long time ago. People forget about it. But it was absolutely one of the greatest moves in the business."

Cargill hopes to dominate new markets as well. Two examples: it makes biodegradable and recyclable plastics out of corn at its $1 billion complex at Blair, Nebraska, and is creating new low-calorie food ingredients for such multinationals as Kraft, Nestle and Coca Cola.

TROUBLED PAST

At times Cargill's power has got it into trouble. In 1937 the Chicago Board of Trade forced the company to sell its corn contracts and Secretary of Agriculture Henry Wallace accused it of trying to "corner" the U.S. corn market. In 1972 Cargill came under attack as it secretly sold millions of tonnes of wheat to Russia, using a U.S. export subsidy program to boot -- and boosting food inflation.

It helps that the firm usually has the backing of Washington. In early 2007, when world grain prices were surging toward all-time highs, it faced a problem in Ukraine. Citing concerns over potential shortages and rising bread prices, Kiev had placed export quotas on cash crops and temporarily stopped granting export licenses for corn, wheat, barley and other grains.

Cargill, as well as fellow U.S. commodity trading firms Bunge and ADM, "agreed to undertake a public relations effort with the goal of creating a political problem for the Government of Ukraine", according to a 2007 diplomatic cable by the U.S. ambassador to Ukraine that was obtained by WikiLeaks and made available to Reuters by a third party.

To achieve this, "it would be necessary to recruit the (Ukrainian) farmers to take an active role. This would be a challenge, since small farmers were unorganized, and most had already cashed in their crops by selling to the traders early... Grain traders welcomed our offer to lend a diplomatic hand," the ambassador wrote.

Asked to comment, Cargill said the company actively backs free trade to boost agriculture in all countries and "is in dialogue with many important audiences, including governments... Additionally, we don't believe export bans are the solution to either high grain prices or price volatility." ADM declined to comment and a spokesman for Bunge could not be reached.

THE 'KOCHTOPUS'

WHO: Koch Industries, founded 1920s by Fred Koch WHERE: Wichita, Kansas WHAT: Oil TURNOVER: $100 billion (2010) CEO: Charles Koch STAFF: 70,000

By Joshua Schneyer

Founded in the 1920s by patriarch Fred Koch, a U.S. engineer who developed a new method of converting oil into gasoline, Koch helped to build a refining network in the Soviet Union in the 1930s. Fred Koch returned to the United States with a visceral hatred for Joseph Stalin and communism. A fiercely libertarian ideology and ultra-competitive engineering prowess live on at Koch Industries' spartan headquarters in Wichita, Kansas, a former Koch executive told Reuters.

With around $100 billion in sales, Koch Industries is a heavyweight among U.S. oil trading firms, and one of the most secretive U.S. corporations. Investors can forget about buying shares in the wildly profitable, family-run firm any time soon.

In oil markets, Koch is a brutally efficient middleman. A master of physical markets, it owns a 4,000-mile U.S. pipeline network and three of the country's most profitable refineries. Many small producers rely almost entirely on Koch to buy, sell and ship their crude. The company now operates in 60 countries.

The Koch brothers, Chairman and CEO Charles and co-owner David Koch, are high-profile supporters of libertarian and anti-regulation U.S. politics. Among their campaigns is one to end the U.S. Environmental Protection Agency's mandate for regulating greenhouse gas emissions. A profile in the New Yorker magazine last year identified the brothers as behind-the-scenes operators who bankroll the U.S. Tea Party movement. The Kochs have denied funding the Tea Party, but their empire's far-reaching tentacles in the political arena have spawned a nickname: the 'Kochtopus'.

The firm's traders, according to two industry sources, made a fortune for Koch in 2009-10 during a contango in U.S. oil markets -- a period when oil for future delivery was higher priced than immediate cargoes. Koch moved quietly to lead a boom in U.S. offshore crude storage, buying millions of barrels at cheap spot prices, parking them in supertankers near its Gulf Coast pipelines, and simultaneously selling into futures markets.

With Koch's easy access to tankers and pipelines, the strategy locked in profits of up to $10 a barrel with virtually no risk, traders said. When spot and futures prices began to converge, Koch would quietly slip crude from the ships into its onshore pipelines. Koch declined to discuss its trading with Reuters.

Former Koch employees were implicated in improper payments to secure contracts in six foreign countries between 2002 and 2008, and the company's officers admitted in a letter made public by a French court last year that "those activities constitute violations of criminal law", according to a report in Bloomberg Markets Magazine this month. The report also details sales by a foreign Koch subsidiary of petrochemical equipment to Iran, which is subject to U.S. sanctions, and a history of criminal or civil penalties for oil spills, a deadly 1996 U.S. pipeline blast, and under-reporting of emissions of benzene, a carcinogen, from a Texas refinery in 1995.

On its website Koch said it dismissed several employees of a French subsidiary upon learning of the improper and unauthorized payments. It also said its foreign units had ended sales to Iran "years ago", and did not violate U.S. law by conducting business with Iran earlier. Koch said its 90s-era pipeline blast was "the only event of its kind" in the company's history, and that a report to Texas regulators was voluntarily submitted by the company in 1995 to reflect higher emissions than it had originally reported. Koch eventually pleaded guilty in 2001 to a felony charge related to its reporting of the benzene emissions.

The firm's far-ranging industrial interests also include chemicals, forestry, ethanol, carbon trading and ranching. Its huge lobbying budget in Washington -- estimated at $10.3 million a year in a recent investigation by the Center for Public Integrity -- stands in contrast to Charles Koch's frugal demeanor within the firm.

The CEO sometimes flies to speaking engagements with no entourage. When in Wichita, he often dines in the Koch cafeteria. When out-of-town employees visit, he has taken them to dinner at seafood chain Red Lobster, a former Koch employee said. "But make no mistake, if you perform well at Koch, you are richly rewarded in salary terms," the person added. "And if you don't, you're out of there fast."

CORN BELT KINGS

WHO: ADM, formerly Archer Daniels Midland, founded 1902 by John Daniels and George Archer BASED: Decatur, Illinois TRADES: Grains, oilseeds, cocoa TURNOVER: $81 billion (2010) CEO: Patricia Woertz STAFF: 30,000

By Karl Plume

"Corn goes in one end and profit comes out the other."

That comment, by Matt Damon's character Marc Whitacre in the 2009 corporate scandal film "The Informant", described how U.S. agricultural firm Archer Daniels Midland Co. turned grain into gold. The line may be simplistic but it's not too far from the truth.

Decatur, Illinois-based ADM is one of the world's biggest commodities traders. It buys and sells multiple crops, mills and grinds and processes them into scores of products, both edible and not, and ships them to markets around the world.

A small Minnesota linseed crushing business more than a century ago, the firm is now is so big its financial performance is often viewed as a barometer of agribusiness as a whole. It owns processing plants, railcars, trucks, river barges and ships. It has trading offices in China, palm plantations and chemical plants across Asia, and silos in Brazil.

"We have a system that monitors the supply and demand needs, because often times they are working independently. For us in the middle, we have the ability then to manage the commodity risk that can be created by the timing differences between those buys and sells," said Steve Mills, ADM's senior executive vice president for performance and growth.

"You'll hear things through the marketplace or the wire services that it's raining someplace or not raining someplace and we'll have people on the ground saying 'I don't know what you're talking about' ... The futures market may take some of that information and run with it. One of the things that gives us an advantage is that we're working in the physical markets as well so (we can) absorb all that information and make the calls."

But ADM's reputation has endured a black eye or two over the years.

A lysine price-fixing scandal in 1993 tarred its name after three top executives were indicted and imprisoned. ADM was fined $100 million by the U.S. government for antitrust violations. The incident was the subject of "The Informant", filmed on site in Decatur.

ADM's environmental record has also been questioned by the Environmental Protection Agency, resulting in fines and forced installation of pollution control measures.

PUTIN, JUDO, CONSPIRACIES

WHO: Gunvor, founded 1997 by Swedish oil trader Torbjorn Tornqvist and Russian/Finnish businessman Gennady Timchenko WHERE: Geneva WHAT: Oil, coal, LNG, emissions TURNOVER: $80 billion 2011, company estimate ($65 billion 2010) CHAIRMAN: Torbjorn Tornqvist STAFF: Fewer than 500

By Dmitry Zhdannikov

When it comes to his critics, Vladimir Putin is a heavyweight puncher. Yet it took Russia's most influential politician almost a decade to publicly address one of the most serious allegations against him.

Critics, including the Russian opposition, put it simply -- Russia's paramount leader helped businessman Gennady Timchenko create the Gunvor oil trading empire, which saw a spectacular rise in the past decade when Putin was president and then prime minister.

Putin finally broke his silence last month: "I assure you, I know that a lot is being written about it, without any participation on my part.

"I have known the citizen Timchenko for a very long time, since my work in St Petersburg," Putin told a group of Russian writers. Putin worked in the mayor's office in the early 1990s when Timchenko and his friends, Putin said, spun off an oil trading unit of the Kirishi oil refinery.

"I never interfered with anything related to his business interests, I hope he will not stick his nose into my business either," Putin said.

Timchenko doesn't need to be told to keep a low profile. He is one of Russia's most private tycoons. And his silence helped feed rumors about Gunvor's remarkable growth.

In 2011 the company will turn over $80 billion, up from just $5 billion in 2004. In his first public interview to Reuters in 2007, Gunvor's Swedish co-founder Tornbjorn Tornqvist was keen to stress that the firm's success was built on its traders' experience and excellent contacts.

"But ... to involve Mr Putin and any of his staff in this dialogue is speculation," he added. That comment didn't help calm rumors and then Timchenko spoke too.

After a newspaper interview he wrote an open letter in 2008 headlined "Gunvor, Putin and me: the truth about a Russian oil trader".

"It is true that I, together with three other businessmen, sponsored a judo club where Mr Putin became honorary president," he wrote. "That is as far as it goes -- yet time and again, the media wrongly jump to the conclusion that the judo club connection means that Mr Putin and I are 'close', then leap into conspiracy-theory mode."

Tornqvist, a former BP trader and keen yachtsman, says he doesn't share the vision of Mark Rich, the father of contemporary trading, that political links are the most prized asset in trading.

"If you don't offer competitive terms, no one will work with you," he told a Russian daily this month. For Gunvor's rivals, too, favoritism is also an overly simple explanation of the company's success. They point to very competitive pricing offered by Gunvor when it comes to Russian oil tenders.

Gunvor's oil dominance has waned in the past two years -- it is handling around a fifth of Russian seaborne oil exports, down from a third three years ago. Perhaps to make up for that, it has moved into new sectors such as natural gas, coal and emissions.

Tornqvist says Gunvor's goal is to become a truly global company. "We know how to close the gap (with Vitol and Glencore) and we are actively catching up," Tornqvist said. Like Vitol, he says, Gunvor has no plans to follow Glencore into an IPO.

THE RICH LINK

WHO: Trafigura, founded 1993 by former Marc Rich traders Claude Dauphin, Eric de Turkheim and Graham Sharp WHERE: Geneva, Switzerland WHAT: Oil, metals TURNOVER: $79 billion (2010) CHAIRMAN: Claude Dauphin STAFF: 6,000

By Dmitry Zhdannikov and Ikuko Kurahone

The godfather of oil trading, Marc Rich, taught one of his most talented apprentices Claude Dauphin almost every trick in the business. Like Rich, Dauphin created a leading commodities trading house by applying a knife-edge approach to business. He has made a fortune.

But there was one lesson that Rich must have cut short: how to avoid jail. While Rich himself fled to Europe in the 1980s to escape possible imprisonment for tax evasion in the United States, Dauphin spent almost six months behind bars in Ivory Coast in 2006-7 in pre-trial detention involving a dispute over toxic waste dumping.

Shortly after the material was dumped, thousands of residents of the city of Abidjan complained of illnesses, including breathing problems, skin irritation and related ailments. The government of Ivory Coast said 16 people died. The material was dumped in open-air sites around Abidjan in August 2006 after being unloaded from a Trafigura-chartered tanker.

Trafigura said it entrusted the waste to a state-registered Ivorian company, Tommy, which dumped the material illegally at sites around Abidjan.

"We went to the Ivory Coast on a mission to help the people of Abidjan, and to find ourselves arrested and in jail as a result has been a terrible ordeal for ourselves and our families," said Dauphin.

Trafigura paid a $200 million settlement and the country's prosecutor declared that there was no evidence of any illegality or misconduct by any Trafigura company or staff.

In London, Trafigura reached a pre-trial settlement to put an end to a class-action suit from some 31,000 residents. The judge said there was no evidence the waste had caused anything more than "flu-like symptoms" and said some media had been irresponsible in their reporting.

The scandal has hardly hampered the firm's stellar growth.

It has grown into the world's third-largest independent oil trader and second-largest industrial metals trader in less than 20 years, since it was set up in the early 1990s by Dauphin and fellow traders Eric de Turckheim and Graham Sharp.

Like rival Vitol, Trafigura has seized the opportunity to get into oil storage as oil majors focus on production. It announced in early October that it may float its storage subsidiary Puma Energy within 18 months.

Trafigura was also quick to recognize the potential of storage in the industrial metals markets. It bought UK-based metals warehouser and logistics firm NEMS in March 2010, a month after Goldman Sachs had acquired rival Metro and several months before Glencore and JP Morgan moved into the business.

SEVEN-YEAR-OLD IN BIG LEAGUE

WHO: Mercuria, founded in 2004 WHERE: Geneva WHAT: ENERGY TURNOVER: $75 billion 2011 company estimate (2010, $47 billion) CEO: Marco Dunand

By Christopher Johnson

Mercuria is just seven years old, but is already one of the world's top five energy traders.

Headquartered in Geneva, Switzerland, and named after Mercury, the god of merchants, Mercuria's business straddles global energy markets.

It has coal mines in Kalimantan in Indonesia, oilfields in Argentina and Canada plus oil trading in Singapore, Chicago, Houston and across Europe.

Its meteoric growth has been piloted by a couple of the sharpest minds in commodities.

Marco Dunand and Daniel Jaeggi, both Swiss, have worked together closely for more than 25 years in a string of commodities companies, buying and selling crude and oil products in many of the hottest oil trading outfits: Cargill, Goldman Sachs' J.Aron, Salomon Brothers' Phibro and Sempra.

In two decades of oil trading, Dunand and Jaeggi built fearsome reputations for seeing profit margins where others could only see potential losses. They were early dealers in a range of financial derivatives that are now commonplace and brought a level of sophistication to their trading books that most of their competitors could often only envy.

"You were always a little worried, taking the other side of their trades," said one European oil product trader, who declined to be identified.

NETWORK

Compared with other independent trading houses, Dunand and Jaeggi are high profile, speaking periodically to the press and giving regular interviews.

Their move to run their own empire came in 2004 when they founded Mercuria, raising capital from two Polish businessmen, Grzegorz Jankielewicz and Slawomir Smolokowski.

Jankielewicz and Smolokowski's company, J+S Group, traded Russian crude oil and was a leading supplier of oil to PKN Orlen, Poland's top oil refiner.

In 2006, J+S was raided by the Polish authorities in connection with an investigation into oil trading in Poland. J+S denied any wrong-doing and suggested the investigation was politically motivated. No suggestions of wrong-doing were leveled against Dunand or Jaeggi.

Dunand, chairman and chief executive, and Jaeggi, head of global trading, used Mercuria to expand their trading base from crude and oil products.

The business has grown to 890 employees in 28 countries with a turnover at $75 billion, trading almost 120 million tonnes of oil, coal and gas.

NO IPO, YET

Dunand says he and Jaeggi have no intention of selling the company they have built so swiftly, or launching an initial public share offering (IPO). But they have seen interest from potential investors, and have considered a tie-up with a sovereign wealth fund.

"We are not thinking about an IPO -- but that doesn't mean we don't have an open mind," Dunand told Reuters in June. "We are keen to consolidate our culture before we could think about changing it. Having said that, we have also been approached by potential investors -- sovereign funds and others -- who wish to make a private-equity type of investment in our company."

Dunand and Jaeggi are Mercuria's largest shareholders but an employee share ownership scheme holds around 40 percent of the company. "We don't see the need to raise money from the market," Dunand said.

A BRIT IN HONG KONG

WHO: Noble Group, founded 1986 by UK scrap metal man Richard Elman WHERE: Hong Kong WHAT: Sugar, coal, oil TURNOVER: $57 billion (2010) EXECUTIVE CHAIRMAN: Richard Elman STAFF: 11,000

By Luke R. Pachymuthu

Founded 25 years ago by Briton Richard Elman, the Hong Kong-based, Singapore-listed Noble Group buys and sells everything from Brazilian sugar to Australian coal.

Noble's shareholders include China's sovereign wealth fund, China Investment Corp., which bought an $850 million stake in 2009, and Korean Investment Corp., which has a minority stake.

Elman, the company's chairman, holds around 30 percent of the company. After dropping out of school he began his career at 15 in a metals scrap yard in the UK. He spent time trading metal in Hong Kong before moving to New York and a stint at commodities trading giant Phibro. Back in Hong Kong, he traded commodities with China in the 1970s and was the first to sell China's Daqing crude oil to the United States.

Noble has grown by acquiring troubled competitors. In 2001, for instance, it bought storied Swiss company Andre & Cie, once one of the world's top five grains traders. Finding itself with a big client base, but short of the physical supplies it needed to meet demand, Noble built its own processing facilities. It's a model it has replicated across various commodities.

Noble is now seeking to spin off its agriculture business with a listing on the Singapore Exchange. The grains business accounts for a third of its earnings and could have a value of more than $5 billion. Wall Street heavyweight JP Morgan is advising Noble on the planned listing.

The company's early forays into trading gas and oil left it with a black eye. Noble quit its global liquefied petroleum gas (LPG) operations in 2010, a year it was censured in Nigeria for discrepancies in gasoline shipping lists. Nigeria's Petroleum Product Pricing Regulatory Agency (PPPRA) said that in one transaction the amount of fuel submitted for subsidies did not match the actual quantity delivered. The company did not comment publicly on this incident.

And it sounded a rare retreat this week when sources close to the company said it had shut its European coal trading operations to focus on Asia and trading.

The China connection continues. In April Noble appointed Li Rongrong, former chairman of the state-owned assets supervision and administration commission of China, as a non-executive director.

PRIVATE FIRM, PUBLIC SPAT

WHO: Louis Dreyfus, founded 1851 by Leopold Louis-Dreyfus WHERE: Paris WHAT: Cotton, rice, grains, orange juice TURNOVER: $46 billion (2010) CEO: Serge Schoen STAFF: 34,000

By Gus Trompiz

In the two years since Margarita Louis-Dreyfus inherited control of the world's top cotton and rice trader following the death of her husband Robert, the woman the French press call "the tsarina" has been at the center of one of the most intriguing struggles in corporate Europe.

Analysts and commentators focused on differences between the forty-something, Russian-born Margarita Louis-Dreyfus and chief executive Jacques Veyrat over how to develop the 160-year-old family firm and whether to list its shares or seek a merger deal.

The winner? The tsarina, or MLD, as the press sometimes also calls her. In April, she and Veyrat told business daily Les Echos that the CEO would be stepping down to make way for Serge Schoen, head of Louis Dreyfus Commodities.

The very public power struggle was all the more remarkable because the company normally keeps everything, from its precise earnings to the exact age of its main shareholder and chairwoman, a secret.

Louis Dreyfus is a well-honed global operator, marketing agricultural commodities from wheat to orange juice. But most analysts think it needs fresh capital to grow, or to buy out minority family shareholders who will have the option to sell their stakes in 2012.

Unsuccessful talks have taken place with Singaporean commodities group Olam International Ltd, while bankers say they have been sounded out about a stock market listing.

Margarita Louis-Dreyfus told Les Echos that a listing, merger or the entry of a private investor were all options. But there's little room for maneuver: the majority stake she inherited is locked up in a trust her husband set up to last for 99 years.

"There is no ideal solution. What matters is that the group and its name survive," she said.

In the wake of Glencore's listing this year, there is interest in another big trading house going public; investors want exposure to long-term demand for commodities.

"I would love for them to be listed on the stock market," said Gertjan van der Geer, who manages an agriculture fund for Swiss bank Pictet. "Cargill and Louis Dreyfus are the large missing players in the commodity trading space."

It doesn't look likely anytime soon. "There is no rush, the company has been private for 150 years so there is no specific timing for changing the shareholding structure," one source close to the company said.

A management shake-up this year at France's most popular football club, Olympique Marseille, offers more proof of Margarita Louis-Dreyfus' determination to defend her husband's legacy and impose hard financial choices.

While pursuing Robert Louis-Dreyfus' passion for the club, which drained millions from his fortune, she has placed strict conditions on new investment.

"Olympique Marseille is at a crossroads," she told supporters in a statement to announce the changes at the club. It's a message that could apply just as well to the Louis Dreyfus group.

(Additional reporting by Jean-Francois Rosnoblet)

CASHING IN ON CHINESE PIGS

WHO: Bunge, founded 1818 by Johann Peter Gottlieb Bunge in Amsterdam WHERE: White Plains, New York. TRADES: Grains, oilseeds, sugar TURNOVER: $46 billion (2010) CHAIRMAN and CEO: Alberto Weissner STAFF: 32,000

By Hugh Bronstein

Two decades ago, Chinese farmers fed their pigs just about anything they could lay their hands on. But since White Plains, New York-based Bunge set up in China in 1998, many have switched to soy pellets. Result: China's pigs are heavier than ever and Bunge has become a key supplier to one of the fastest growing economies in the world.

The company, which went public 10 years ago, realized early that rising incomes in Asia could be fed by Brazil and Argentina, two of the last remaining countries with new farmland left for crop cultivation.

It helps that the company's CEO Alberto Weisser is a Brazilian, and that Bunge has more than 100 years experience in South America.

"Asian demand for South American soybeans has exploded over the last five years and Bunge is arguably the best positioned company in the world as it relates to servicing and profiting from the Asian demand trend," said Jeff Farmer, an analyst who follows the company for Jefferies & Company in Boston.

Founded in 1818 in Amsterdam, the company is the world's No.1 oilseed processor. Along the way it has moved headquarters to Belgium, Argentina, Brazil and then the United States.

"They go where the business is," said an industry insider who asked not to be named. "No sentimental attachments to any country or location. What matters is results, and you can see that in the way they trade."

It doesn't always work. In May, Argentina kicked Bunge off the country's exporters' register after the government alleged it had evaded $300 million in taxes, an accusation the company denies. Argentina's tax office is investigating dozens of other agricultural exporters as well.

Despite not being on the registry, Bunge continues to export grains and agricultural products as usual, but it cannot cash in on certain tax benefits and it faces hurdles transporting goods within Argentina, which analysts say could hurt the company's bottom line.

ASIA'S NEW SUGAR KING

WHO: Wilmar International, founded 1991 WHERE: Singapore WHAT: Palm oil, grains, sugar TURNOVER: $30.4 billion (2010) CHAIRMAN AND CEO: Kuok Khoon Hong STAFF: 88,000 plus

By Harry Suhartono and Naveen Thakral

Around two decades ago, Kuok Khoon Hong decided to leave the business empire of his billionaire uncle Robert Kuok to set up an edible oil business with a big bet: China.

He competed fiercely with Indonesia's Salim group, the business group commanded by his uncle, and won, to dominate the edible oil market in the world's most populous nation.

Wilmar is now the biggest soy player in China with a 20 percent market share, measured in processing capacity. It is also the largest producer of consumer pack edible oils with about 45 percent market share.

Wilmar's strategy is to have its fingers in every part of the supply chain, from point of origin to destination.

In the palm oil business, for example, it owns plantations, mills, refiners, shippers, bottlers and the distribution network, in both the top producers, Indonesia and Malaysia, and the top consumers, India and China.

That gives its traders the advantage of timely market intelligence.

"We have a daily sales report from every corner where we operate and if we see sales slowing over a few weeks, we get to know the changing trend before others," one employee said, on condition of anonymity.

In 2006 Kuok, now 62, orchestrated a $4.3 billion merger which consolidated his uncle's palm oil assets into Wilmar, making it the world's largest listed palm oil firm.

Last year he surprised the market when he trumped China's Bright Food in a $1.5 billion deal to buy Australia's Sucrogen.

That complements his plan to set up a 200,000 hectares plantation in Indonesia's Papua island, which could make him the new "Asian sugar king", a title once hold by his uncle.

With nearly $10 billion worth of cash and bank deposits on Wilmar's balance sheet, Kuok is unlikely to stop his expansion drive there. Investors say he might already have his sights set on Brazil, to strengthen his position in the global sugar market.

THE CUSHING CUSHION

WHO: Arcadia, founded 1988 by Japan's Mitsui & Co BASED: London TRADES: Oil TURNOVER: $29 billion, Reuters estimate OWNER: John Fredriksen STAFF: 100

By Caroline Copley and Joshua Schneyer

Arcadia Petroleum, the London-based oil trading firm owned by billionaire oil tanker magnate John Fredriksen, was thrust into the spotlight in May when U.S. commodities regulators sued it for allegedly manipulating U.S. oil markets in 2008.

In one of its biggest-ever crackdowns, the U.S. Commodity Futures Trading Commission alleges Arcadia traders amassed large physical crude positions in Cushing, Oklahoma, to create the appearance of tight supply at the delivery hub for U.S. oil futures. Fredriksen's traders then hurriedly sold the physical crude at a loss, the CFTC lawsuit claims, ending expectations for tight supplies. Overall Arcadia profited by $50 million in derivatives markets as oil futures spreads collapsed, according to the suit.

In a May interview with Reuters, Fredriksen refuted the charges and shot back that "maybe they (U.S. regulators) are trying to get some revenge" for the 2010 BP oil spill in the Gulf of Mexico. Several of Fredriksen's traders worked for BP in the early 2000s, where aggressive oil trading at Cushing turned huge profits, and also led to BP paying fines for alleged trading violations.

"It is a normal situation for oil traders ... They are buying and selling oil. That's what it is all about," Fredriksen said of the recent CFTC charges.

Risk has often paid off handsomely for Fredriksen. With a personal fortune estimated by Forbes at $10.7 billion, the 67-year-old was Norway's richest man until he abandoned his citizenship in 2006 to become a national of Cyprus, where tax rates are lower.

Beyond Arcadia, Fredriksen's stable of commodities-related firms includes MarineHarvest, a global salmon-farming conglomerate billed as "the world's largest seafood company." He also owns oil tanker operator Frontline, U.S. oil trader Parnon -- also named in the CFTC lawsuit -- energy driller Seadrill and gas distributor Golar LNG.

Fredriksen became a leading oil shipping magnate well before buying Arcadia, in 2006. His 28-year-old twins Kathrine and Cecilie play a growing role in his sprawling business empire, according to press reports.

Arcadia doesn't make its revenues public. With 800,000 barrels a day to market, a volume similar to OPEC country Qatar, Arcadia's annual gross revenue from oil could be around $29 billion based on current prices.

The company lists its trade in paper derivatives as larger still, or about 10 million barrels a day.

Arcadia has faced controversy before. Founded in 1988 by Japanese trading giant Mitsui Inc., it was sued in 2000 by independent US refiner Tosco for allegedly conspiring to jack up prices of European benchmark Brent oil by cornering part of the North Sea physical crude market. The suit was settled out of court for an undisclosed sum.

Arcadia often trades large volumes of oil from Nigeria and Yemen, where it boasts close relationships with state oil firms. In a 2009 State Department cable from Yemen, obtained by WikiLeaks and provided by a third party to Reuters, sources told U.S. diplomats that the company used intimidation tactics including kidnapping threats to buy Yemeni crude at below market prices. Arcadia's chief executive in Singapore, Stephen Gibbons, denied the contents of the cable and told Reuters the kidnapping allegations were "ludicrous".

60 YEARS OUT OF THE LIMELIGHT

WHO: Mabanaft WHERE: Rotterdam WHAT: Oil TURNOVER: $15 billion, Reuters estimate CEO: Jan-Willem van der Velden STAFF: 1,772

By Jessica Donati

Mabanaft's profile is low even by the secretive standards of other independent oil traders. The company has spent six decades trying to keep it that way. Its website reveals little more than that it is the trading arm of privately owned oil company Marquard & Bahls.

A rare news release announced that Jan-Willem van der Velden, who started as an international trader at the company in 1997, would take over as CEO from January this year.

Van der Velden took the reins of a company on a roll. Mabanaft sold 20 million tonnes of oil in 2010, up from 18 million tonnes in 2009. Pre-tax income for its parent company Marquard & Bahls was $274 million, up from $252 million the previous year.

That's still a lot less than the billions the biggest independent oil traders make and a long way off the revenue of Marquard & Bahls' oil tanking division, the second largest in the world after Vopak. Which may be why Mabanaft wants to expand beyond its northern European heartland.

From the 43rd floor of a Rotterdam skyscraper, staff members can look out over a network of rivers toward some of Europe's biggest refineries. But Mabanaft has also gradually opened offices in Singapore and the United States and, in the summer of 2010, a representative office in India.

As usual, details are scant. "Mabanaft is aiming to further diversify its product portfolio by pursuing a controlled geographic growth strategy," is all communications manager Maren Mertens is able to offer on the subject. Geography isn't the sole focus of expansion -- it has moved into naphtha, LPG and wood pellets.

CASHEWS TO FORBES

WHO: Olam, founded 1989 by the Kewalram Chanrai Group, began trading cashews from Nigeria WHERE: Singapore WHAT: Coffee, cocoa, rice, grains, sugar TURNOVER: $11 billion (2009/10) CEO: Sunny Verghese STAFF: 13,000 plus

By Harry Suhartono

A wealthier world needs more food. That's the argument of Sunny Verghese, chief executive of Singapore-based trading firm Olam International.

"We haven't seen this pace of population growth in our living memory," Verghese told a conference in Singapore late last year. "We have to increase food production by 50 percent by 2030, and 80 percent by 2050, with our hands tied behind our back," he said, referring to constraints to boosting output such as the lack of land, water and infrastructure.

Verghese still plans to cash in. In two decades the Bangalore-born trader has built Olam into a $4.5 billion company involved in around 20 different commodities including coffee, cocoa, rice, grains and sugar, from a startup that sold Nigerian cashew nuts.

These days, Olam has upstream operations in everything from a coffee plantation in Laos to a rice business in Thailand, from almonds in Australia to cashews in Africa. The firm is now the world's largest shipper of Robusta coffee and counts Nestle, Hershey, General Mills and Sara Lee as clients. It is also the world's second largest trader of rice after Louis Dreyfus.

The French trading giant approached Olam with a merger proposal in 2010, but talks failed earlier this year.

Verghese, who Forbes says is worth $190 million, believes he can go it alone and aims to quadruple the company's value by 2015. It helps that Olam has backing in high places: Singapore state investor Temasek holds a 14 percent stake in the trading firm.

Some analysts point to risk factors: Olam's exposure to natural disasters, such as recent flooding in Australia, and social or political unrest such as that in Ivory Coast.

IN SEARCH OF A REFINERY

WHO: Hin Leong, founded 1963 supplying diesel to fishing boats WHERE: Singapore WHAT: Oil and tankers TURNOVER: $8 billion (2010) CHAIRMAN AND CEO: Lim Oon Kuin STAFF: About 100

By Yaw Yan Chong

Lim Oon Kuin arrived in Singapore from China over 50 years ago, and started to deliver diesel by bicycle to boatmen. Now in his mid-60s, the reclusive trader is busy with his latest empire-building effort: getting government approval to build the city-state's fourth oil refinery.

Known as OK Lim, the founder of Singapore's Hin Leong Group wants to build the company from oil trader into an integrated company. He's well on the way. A fleet of tankers and Asia's largest commercial storage facility are among the company's assets.

The $5-billion refinery would pit Hin Leong against refineries already operated in Singapore by oil majors Shell, ExxonMobil and a joint venture between Chevron and China's PetroChina.

Hin Leong made its name in the hard-fought Asia fuel oil and distillates market over 20 years ago, and is arguably the largest independent distillates trader in Asia, regularly mounting successful trading plays in the Singapore market. It also has a substantial presence in Asia's fuel oil market, the world's largest.

Lim's Chinese connections have played a big part in the company's success. It focused initially on shipping fuel oil cargoes to the mainland, a relationship that has since deepened. Hin Leong is joining hands with several Chinese firms to build the proposed Singapore refinery, even as it seeks to build a larger oil storage facility in the South Chinese province of Fujian.

Lim's biggest bet may have been an unprecedented 1997 spree in which Hin Leong bought 30 million barrels of jet fuel and diesel in the key Singapore market -- worth nearly US$800 million over a three-month span. The jury is still out among rival traders on whether he made or lost a fortune that summer, a debate Lim is unlikely to settle publicly.

In his only media interview, with Reuters in 2006, Lim credited his success to investment in his tanker armada -- the "secret weapon" that helped him set up stealthy and profitable deals in the 1990s -- and his philosophy of perseverance.

"Sometimes you get it wrong, but you have to accept it," he said.

China's Money-Printing Addiction

2011-10-21T01:46:00.000-07:00

Jack H. Barnes

January 11, 2011

A couple of articles discussing the speed at which the Chinese government is hitting the printing presses crossed my desk today.

Combined, they give an interesting view into the economic dynamics at work in China as it attempts to adjust to its new role as an economic superpower.

This article from Taiwan points towards a money supply out of control. It has some interesting tidbits of data and a great quote.

In the past ten years, China’s M2 has expanded at the average rate of 18.8% a year, despite the fact that the country, which has an average gross domestic product (GDP) growth rate of 10.9% and an average inflation rate of 3.2%, needs only 14.1% of growth in money supply to sustain its economic development.

This has driven China’s M2-to-GDP ratio in the past decade to the highest in the world.

“In the past 30 years, we have used excessive money supply to rapidly advance our economy,” said Wu Xiaoling, vice chairman of the Financial and Economic Affairs Committee of China’s National People’s Congress.

China has not only been the country that prints money at the fastest rate but also been the country with the largest money supply in the world in the past decade, according to the Chinese-language Southern Weekly.

Furthermore, China continued to be the largest money-supplying country in 2010 as its M2, a broad measure of money supply, was up 19.46% at the end of November from a year earlier, said the weekly.

This compares with 3.3% and 2.5% of annual M2 growth in the US and Japan respectively over the same period.

It appears to have caused a 9 times increase in Beijing property prices in the last 8 years. While China is focused on growing its economic engine, the damage it is doing to itself is increasing.

The difference in the value of the average mud hut in the village compared to the average cost of a new high rise condo has never been larger. Don’t laugh, villagers do make it into the city, and can quickly see the difference in valuations. It gets worse when their property is taken from them for new local developments, at ever high retail prices. The trickle down valuations are not working in China any better than they have worked in the US.

The implications are pointing towards a Boom Bust Gloom type of cycle. China is one food staple event away from the masses realizing that the dream has passed them by. The cost of food is going to severely impact the cost of migrant workers ability to survive. Step increases in wages will be necessary sooner rather than later.

The NY Times has an article today on Chinese foreign currencies swelling at above trend expectations. In simple terms, as China collects FX reserves, it requires its internal banks to release the same amount of capital for domestic growth. Thus they amplify their FX earnings with domestic stimulus.

The Chinese foreign reserves leaped by $199 billion in the fourth quarter, to $2.85 trillion. The increase was much larger than economists expected, and the numbers suggested that China had about doubled its intervention in currency markets to about $2 billion a day.

This is why the Chinese economy has performed like a “Tour de France” rider, bouncing back quicker and climbing faster than anyone else. They are juicing their economy every way they can. Their economy will perform amazing, right up until it has a heart attack.

If China was to acknowledge how undervalued the Yuan appears to be, it would have to raise its internal stimulus program to even higher rates. They can’t handle the additional stimulus without hyper inflation breaking out.

They can’t slow down, and they can’t go faster. Catch-22 is back.

I believe this is the second edge to the economic sword hanging over China. They are now addicted to needing an ever increasing supply of foreign capital, to stimulate the internal money growth rates.

If growth ever went negative, the system is not setup to allow a pretty unwind. There is only expectation of future growth. Growth only lasts, until it doesn’t happen, which China is not prepared for.

While China has control of its own internal domestic markets, and it has been allowed to keep a near peg to the US dollar for the last decade. It cannot provide endless stimulus to both its internal markets, its external markets and control inflation.

One of three, YES. Two of Three, Maybe. Three of Three, ZERO CHANCE.

The coming months and years ahead are going to be affected by the out of control growth of today. The affects of a runaway money supply are well known. Anyone who is a student of economics knows what is going to happen next, but like all great bubbles, its impossible to time when they will pop. China is no different.

They are so dependent on demand growth, they have decided to try and prop up the European bureaucrats with fresh capital. These new private placements in European Sovereigns will help keep Europe from dissolving into a mess this winter, while allowing the problems to fester at both ends longer.

Combined, when Europe does shatter, it will hurt the China worse. They will have thrown away their national savings, on buying debt from an international organization that is dissolving under its own weight in front of everyone in the world. The leading party will have used up internal domestic creditability by publicly propping up a coalition of the unwilling to be economic governed with Chinese home savings.

The old Chinese proverb/curse about interesting times, comes to mind.

January 11, 2011

Chinese Foreign Currency Reserves Swell by Record Amount

By KEITH BRADSHER

BEIJING — China’s foreign exchange reserves surged in the fourth quarter by a record amount while the money circulating within the Chinese economy also climbed more than expected in December, according to government statistics released Tuesday that underline the country’s worsening inflation dilemma.

The Chinese government has been printing renminbi at a furious pace in order to buy foreign currencies like the dollar and the euro, which are pouring into the country through trade surpluses and foreign investment. The People’s Bank of China, the country’s central bank, has been doing so in an effort to hold down the value of the renminbi and preserve a competitive advantage in foreign markets for exporters in China and the tens of millions of workers they employ.

The additional renminbi issued to pay for rising foreign exchange reserves will make China’s inflation problem even worse, said Diana Choyleva, an economist in Hong Kong for Lombard Street Research. The extra renminbi come as the Chinese central bank has been grappling with the additional money that it pumped into the Chinese banking system in 2009 and early 2010 to keep the economy growing through the global financial crisis.

“Considering that they engineered the most dramatic monetary expansion in their own history and in the world’s since World War II, there was a large monetary overhang” even before the recent currency market intervention, Ms. Choyleva said.

The sharp increase in foreign reserves in the last quarter and the inflation that they threaten to cause in the Chinese economy may embolden American officials to press harder for China to loosen its hold on the renminbi. President Hu Jintao of China is scheduled to visit the United States next week, and Washington officials have already said that currency issues will be on the agenda.

Chinese officials are likely to respond, however, by pointing to data released on Monday that showed that the trade surplus narrowed slightly in 2010 compared to 2009, and fell particularly in December.

An analysis of the data by Standard Chartered said that trade and government-approved foreign investments into China accounted for less than half of the increase in foreign reserves in the fourth quarter; investors around the world have also been putting money into Chinese real estate, bank accounts and other investments despite efforts by the Chinese government to discourage these capital inflows.

The Chinese foreign reserves leaped by $199 billion in the fourth quarter, to $2.85 trillion. The increase was much larger than economists expected, and the numbers suggested that China had about doubled its intervention in currency markets to about $2 billion a day.

Foreign reserves had risen by $194 billion in the third quarter, but economists had estimated that about half of that increase had come from interest payments and an appreciation of the value of the euro. China holds an estimated $700 billion in euro-denominated assets that go up and down in dollar terms as the value of the euro fluctuates.

The value of the euro has declined 2.1 percent against the dollar. So the sharp increase in overall value of the foreign reserves in the fourth quarter took place even as the value of China’s euro-denominated bonds and other assets was shrinking, economists said.

The People’s Bank of China also said Tuesday that the country’s broadly measured money supply, known as M2, was 19.7 percent higher in December than a year earlier.

Economists had been expecting an increase of 19 percent.

Broad measures of money supply reflect not just the extra renminbi put into the financial system by the central bank but also the pace at which banks are lending that money. Banking regulators have repeatedly ordered banks to slow their lending, with limited effect.

“Apparently, their jawboning to the banks is not working as effectively as they’ve wanted,” said William Belchere, the chief global economist at Mirae Asset, a big South Korean financial firm.

In an attempt to restrict lending, the People’s Bank of China raised six times last year the share of bank assets that banks must keep on deposit at the central bank. But banks have partly evaded those controls by moving loans and other assets off their balance sheets through securitization transactions.

Consumer prices rose 5.1 percent higher in November than a year earlier, according to government data. But many Chinese economists say that the consumer price index understates the true extent of inflation, because it excludes soaring costs for owner-occupied housing and is based heavily on the prices of an outdated list of consumer products that are no longer popular.

The National Bureau of Statistics has said that it is actively studying ways to improve the consumer price index. A bureau official said last week that inflation figures for December would be released on Jan. 20 or 21.

China's Money Supply "Unprecedented in History": Report

Staff Reporter 2011-01-08 18:50 (GMT+8)

China has not only been the country that prints money at the fastest rate but also been the country with the largest money supply in the world in the past decade, according to the Chinese-language Southern Weekly.

Furthermore, China continued to be the largest money-supplying country in 2010 as its M2, a broad measure of money supply, was up 19.46% at the end of November from a year earlier, said the weekly.

This compares with 3.3% and 2.5% of annual M2 growth in the US and Japan respectively over the same period.

As of the end of November last year, China's broad money supply rose to 71.03 trillion yuan (US$10.71 trillion) from a year earlier, larger than that of the US and Japan, while its M1, a narrower measure of money supply, increased 22.1% to 25.94 trillion yuan (US$3.91 trillion), according to statistics from the central People's Bank of China.

In the past ten years, China's M2 has expanded at the average rate of 18.8% a year, despite the fact that the country, which has an average gross domestic product (GDP) growth rate of 10.9% and an average inflation rate of 3.2%, needs only 14.1% of growth in money supply to sustain its economic development.

This has driven China's M2-to-GDP ratio in the past decade to the highest in the world.

"In the past 30 years, we have used excessive money supply to rapidly advance our economy," said Wu Xiaoling, vice chairman of the Financial and Economic Affairs Committee of China's National People's Congress.

The reason for the large increases in China's money supply is related to its exchange rate mechanism. According to the country's regulations, for every US$1 increase in foreign exchange reserves, China's central bank has to release the equivalent amount of yuan into the economy.

The annual growth of China's foreign exchange reserves jumped to 28% after it joined the World Trade Organization in 2001 and by the end of September 2010, China's foreign exchange reserves were 18.3 times the 1998 amount. Japan's foreign exchange reserves during the same time last year were less than half of China's.

China has no choice but to print more money in the face of its massive foreign exchange reserves, said the Southern Weekly, adding that the excessive money supply that has resulted is a phenomenon unprecedented in the history of the world economy.

The excess money flows into the property market and any assets available for making investments, causing land, housing and commodity prices to surge.

Since 2003, land prices in Beijing and its surrounding areas have increased nine times. Furthermore,the prices of approximately 70% of agricultural produce in 36 cities in China have risen since July last year.

Madoff Trustee Sues Lion Global, 6 Firms Seeking $172 Million Recovery

2011-09-16T18:25:00.000-07:00

By Karen Gullo and Linda Sandler

Aug 19, 2011

The liquidator of Bernard L. Madoff’s firm sued Lion Global Investors Ltd. and at least six other companies to recover at least $172.8 million they allegedly received from investments made with the con man by Fairfield Sentry Ltd.

Irving Picard, the trustee overseeing the liquidation of Bernard L. Madoff Investment Securities LLC, claims Fairfield, a so-called feeder fund to the Madoff company, transferred “customer property” to Lion Global, a Singapore-based asset- management company; Quilvest Finance Ltd., a unit of Luxembourg- based investor Quilvest SA; and five other entities, according to filings in U.S. Bankruptcy Court in Manhattan.

Seven complaints filed yesterday seek at least $172.8 million for investors in Madoff’s Ponzi scheme. Picard demanded $11.5 million from First Gulf Bank PJSC (FGB), the United Arab Emirates lender owned by Abu Dhabi’s ruling family. Picard said he has the authority to take back the transfers as he works to recover money for Madoff customers.

Picard, after targeting and sometimes settling with the largest feeder funds, such as Fairfield Sentry, is pursuing comparatively small amounts from investors who redeemed money from the feeders before Madoff’s 2008 arrest. The trustee’s settlement with Walter Noel’s Fairfield Sentry was approved in court in June.

HSBC Ruling

The trustee last month lost the right to claim almost $9 billion in damages from HSBC Holdings Plc (HSBA) and feeder funds after a ruling by U.S. District Judge Jed Rakoff, who said Picard was free to pursue bankruptcy claims. Madoff is serving a 150-year sentence in a prison in North Carolina.

Picard is seeking at least $50.6 million from Lion Global, according to the filing. Lion Global’s lawyers are looking into the lawsuit, Mae Wong, a spokeswoman for the Singapore firm, said today.

Lion Global, through its joint venture with Fairfield Greenwich Group, had sold about $45 million of the feeder fund to investors, according to a December 2008 Singapore regulatory filing.

Lion Global, which had S$28.7 billion ($24 billion) of assets under management as of June 30, is 70 percent-owned by life insurer Great Eastern Holdings Ltd. (GE) and 30 percent-owned by Oversea-Chinese Banking Corp., according to its website. Great Eastern is controlled by Oversea-Chinese, Southeast Asia’s second-largest bank.

A call to Quilvest USA in New York seeking comment on the lawsuit after regular business hours wasn’t immediately returned. A call to First Gulf Bank wasn’t answered after regular business hours.

The case is Picard v. Lion Global, 11-2540, U.S. Bankruptcy Court, Southern District of New York (Manhattan). -- Bloomberg

Madoff trustee sues Lion Global for S$61.2 million

2011-09-16T18:23:00.000-07:00

Aug 20, 2011

NEW YORK - Singapore asset management company Lion Global Investors (LGI) has been sued in New York for US$50.6 million (S$61.2 million) by the liquidator of the firm of convicted conman Bernard Madoff.

According to filings in United States Bankruptcy Court in Manhattan, Mr Irving Picard, the trustee overseeing the liquidation of Bernard L Madoff Investment Securities, claims Fairfield, a so-called feeder fund to the Madoff company, had transferred funds to LGI.

LGI, through its joint venture with Fairfield, had sold about US$45 million of the feeder fund to investors, according to a December 2008 regulatory filing in Singapore.

When asked to comment on the legal action, an LGI spokesperson would only say: "Our legal advisors are looking into the matter."

Launched in September 2005 following the merger of the asset management arms of the OCBC banking group and Great Eastern insurance group, LGI is one of the largest asset management companies in Singapore and South-east Asia, managing about S$28.7 billion as of Dec 31 last year.

The OCBC Group has an effective interest of 91 per cent in LGI, of which 70 per cent is held through Great Eastern.

Apart from LGI, the liquidator is suing at least six other companies to recover a total of about US$172.8 million they allegedly received from investments made with Madoff by Fairfield.

Mr Picard said he has the authority to take back the transfers as he works to recover money for Madoff customers.

The trustee last month lost the right to claim almost US$9 billion in damages from HSBC Holdings and feeder funds after a ruling by US District Judge Jed Rakoff.

But the judge said Mr Picard was free to pursue bankruptcy claims.

Madoff, who ran the world's largest Ponzi scheme estimated at US$65 billion, is serving a 150-year sentence in a North Carolina prison for crimes including securities and wire fraud, money laundering and perjury.

Considering a PIGs default

2011-09-16T07:01:00.000-07:00

September 15th, 2011

By George Soros, Project Syndicate

To resolve a crisis in which the impossible has become possible, it is necessary to think the unthinkable. So, to resolve Europe’s sovereign-debt crisis, it is now imperative to prepare for the possibility of default and defection from the eurozone by Greece, Portugal, and perhaps Ireland.

In such a scenario, measures will have to be taken to prevent a financial meltdown in the eurozone as a whole. First, bank deposits must be protected. If a euro deposited in a Greek bank would be lost through default and defection, a euro deposited in an Italian bank would immediately be worth less than one in a German or Dutch bank, resulting in a run on the deficit countries’ banks.

Moreover, some banks in the defaulting countries would have to be kept functioning in order to prevent economic collapse. At the same time, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Finally, government bonds issued by the eurozone’s other deficit countries would have to be protected from contagion. (The last two requirements would apply even if no country defaulted.)

All of this would cost money, but, under the existing arrangements agreed by the eurozone’s national leaders, no more money is to be found. So there is no alternative but to create the missing component: a European treasury with the power to tax and, therefore, to borrow. This would require a new treaty, transforming the European Financial Stability Facility (EFSF) into a full-fledged treasury.

But this presupposes a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro. That is a grave mistake. The euro exists, and the global financial system’s assets and liabilities are so intermingled on the basis of the common currency that its collapse would cause a meltdown beyond the capacity of the German authorities - or any other - to contain. The longer it takes for the German public to realize this cold fact, the higher the price that they, and the rest of the world, will have to pay.

The question is whether the German public can be convinced of this argument. Chancellor Angela Merkel may not be able to persuade her entire coalition of its merits, but she could rely on the opposition to build a new majority in support of doing what is necessary to preserve the euro. Having resolved the euro crisis, she would have less to fear from the next election.

Preparing for the possible default or defection of three small countries from the euro does not mean that those countries would necessarily be abandoned. On the contrary, the possibility of an orderly default - financed by the other eurozone countries and the International Monetary Fund - would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle - now threatening all of the eurozone’s deficit countries - whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.

Leaving the eurozone would make it easier for the most distressed countries to regain competitiveness. But, if they are willing to make the necessary sacrifices, they could also remain: the EFSF would protect their domestic bank deposits, and the IMF would help to recapitalize their banking systems, which would help these countries escape from their current trap. Either way, it is not in the European Union’s interest to allow these countries to collapse and drag down the entire global banking system with them.

The EU’s member countries, and not only those in the eurozone, must accept that a new treaty is needed to save the euro. That logic is clear. So the discussions about what to include in such a new treaty ought to begin immediately, because, even with European leaders under extreme pressure to agree quickly, negotiations will necessarily be a prolonged affair. Once the principle is agreed, however, the European Council could authorize the ECB to step into the breach, indemnifying it from solvency risks in advance.

Having in sight a solution to the eurozone’s sovereign-debt crisis would be a source of relief for financial markets. Even so, because any new treaty’s terms will inevitably be dictated by Germany, a severe economic slowdown would be almost certain. That might induce a further change of attitude in Germany, in turn allowing the adoption of counter-cyclical policies. At that point, growth in much of the eurozone could resume.

The views expressed in this article are solely those of George Soros. Copyright: Project Syndicate, 2011.

Does the Euro Have a Future?

2011-09-16T03:29:00.000-07:00

By George Soros

The euro crisis is a direct consequence of the crash of 2008. When Lehman Brothers failed, the entire financial system started to collapse and had to be put on artificial life support. This took the form of substituting the sovereign credit of governments for the bank and other credit that had collapsed. At a memorable meeting of European finance ministers in November 2008, they guaranteed that no other financial institutions that are important to the workings of the financial system would be allowed to fail, and their example was followed by the United States.

Angela Merkel then declared that the guarantee should be exercised by each European state individually, not by the European Union or the eurozone acting as a whole. This sowed the seeds of the euro crisis because it revealed and activated a hidden weakness in the construction of the euro: the lack of a common treasury. The crisis itself erupted more than a year later, in 2010.

There is some similarity between the euro crisis and the subprime crisis that caused the crash of 2008. In each case a supposedly riskless asset—collateralized debt obligations (CDOs), based largely on mortgages, in 2008, and European government bonds now—lost some or all of their value.

Unfortunately the euro crisis is more intractable. In 2008 the US financial authorities that were needed to respond to the crisis were in place; at present in the eurozone one of these authorities, the common treasury, has yet to be brought into existence. This requires a political process involving a number of sovereign states. That is what has made the problem so severe. The political will to create a common European treasury was absent in the first place; and since the time when the euro was created the political cohesion of the European Union has greatly deteriorated. As a result there is no clearly visible solution to the euro crisis. In its absence the authorities have been trying to buy time.

In an ordinary financial crisis this tactic works: with the passage of time the panic subsides and confidence returns. But in this case time has been working against the authorities. Since the political will is missing, the problems continue to grow larger while the politics are also becoming more poisonous.

It takes a crisis to make the politically impossible possible. Under the pressure of a financial crisis the authorities take whatever steps are necessary to hold the system together, but they only do the minimum and that is soon perceived by the financial markets as inadequate. That is how one crisis leads to another. So Europe is condemned to a seemingly unending series of crises. Measures that would have worked if they had been adopted earlier turn out to be inadequate by the time they become politically possible. This is the key to understanding the euro crisis.

Where are we now in this process? The outlines of the missing ingredient, namely a common treasury, are beginning to emerge. They are to be found in the European Financial Stability Facility (EFSF)—agreed on by twenty-seven member states of the EU in May 2010—and its successor, after 2013, the European Stability Mechanism (ESM). But the EFSF is not adequately capitalized and its functions are not adequately defined. It is supposed to provide a safety net for the eurozone as a whole, but in practice it has been tailored to finance the rescue packages for three small countries: Greece, Portugal, and Ireland; it is not large enough to support bigger countries like Spain or Italy. Nor was it originally meant to deal with the problems of the banking system, although its scope has subsequently been extended to include banks as well as sovereign states. Its biggest shortcoming is that it is purely a fund-raising mechanism; the authority to spend the money is left with the governments of the member countries. This renders the EFSF useless in responding to a crisis; it has to await instructions from the member countries.

The situation has been further aggravated by the recent decision of the German Constitutional Court. While the court found that the EFSF is constitutional, it prohibited any future guarantees benefiting additional states without the prior approval of the budget committee of the Bundestag. This will greatly constrain the discretionary powers of the German government in confronting future crises.

The seeds of the next crisis have already been sown by the way the authorities responded to the last crisis. They accepted the principle that countries receiving assistance should not have to pay punitive interest rates and they set up the EFSF as a fund-raising mechanism for this purpose. Had this principle been accepted in the first place, the Greek crisis would not have grown so severe. As it is, the contagion—in the form of increasing inability to pay sovereign and other debt—has spread to Spain and Italy, but those countries are not allowed to borrow at the lower, concessional rates extended to Greece. This has set them on a course that will eventually land them in the same predicament as Greece. In the case of Greece, the debt burden has clearly become unsustainable. Bondholders have been offered a “voluntary” restructuring by which they would accept lower interest rates and delayed or decreased repayments; but no other arrangements have been made for a possible default or for defection from the eurozone.

These two deficiencies—no concessional rates for Italy or Spain and no preparation for a possible default and defection from the eurozone by Greece—have cast a heavy shadow of doubt both on the government bonds of other deficit countries and on the banking system of the eurozone, which is loaded with those bonds. As a stopgap measure the European Central Bank (ECB) stepped into the breach by buying Spanish and Italian bonds in the market. But that is not a viable solution. The ECB had done the same thing for Greece, but that did not stop the Greek debt from becoming unsustainable. If Italy, with its debt at 108 percent of GDP and growth of less than 1 percent, had to pay risk premiums of 3 percent or more to borrow money, its debt would also become unsustainable.

The ECB’s earlier decision to buy Greek bonds had been highly controversial; Axel Weber, the ECB’s German board member, resigned from the board in protest. The intervention did blur the line between monetary and fiscal policy, but a central bank is supposed to do whatever is necessary to preserve the financial system. That is particularly true in the absence of a fiscal authority. Subsequently, the controversy led the ECB to adamantly oppose a restructuring of Greek debt—by which, among other measures, the time for repayment would be extended—turning the ECB from a savior of the system into an obstructionist force. The ECB has prevailed: the EFSF took over the risk of possible insolvency of the Greek bonds from the ECB.

The resolution of this dispute has in turn made it easier for the ECB to embark on its current program to purchase Italian and Spanish bonds, which, unlike those of Greece, are not about to default. Still, the decision has encountered the same internal opposition from Germany as the earlier intervention in Greek bonds. Jürgen Stark, the chief economist of the ECB, resigned on September 9. In any case the current intervention has to be limited in scope because the capacity of the EFSF to extend help is virtually exhausted by the rescue operations already in progress in Greece, Portugal, and Ireland.

In the meantime the Greek government is having increasing difficulties in meeting the conditions imposed by the assistance program. The troika supervising the program—the EU, the IMF, and the ECB—is not satisfied; Greek banks did not fully subscribe to the latest treasury bill auction; and the Greek government is running out of funds.

In these circumstances an orderly default and temporary withdrawal from the eurozone may be preferable to a drawn-out agony. But no preparations have been made. A disorderly default could precipitate a meltdown similar to the one that followed the bankruptcy of Lehman Brothers, but this time one of the authorities that would be needed to contain it is missing.

No wonder that the financial markets have taken fright. Risk premiums that must be paid to buy government bonds have increased, stocks have plummeted, led by bank stocks, and recently even the euro has broken out of its trading range on the downside. The volatility of markets is reminiscent of the crash of 2008.

The authorities are doing what they can to forestall an immediate breakdown. The Greeks are meeting the troika’s demands so as to receive the next installment of the rescue package. The ECB is allowing banks to borrow dollars for up to three months instead of just one week, as has been the case. The Bundestag is expected to pass legislation establishing the EFSF. These steps will delay the climax from September to December.

Unfortunately, the capacity of the financial authorities to take additional measures has been severely restricted by the recent ruling of the German Constitutional Court. It appears that the authorities have reached the end of the road with their policy of “kicking the can down the road.” Even if a catastrophe can be avoided, one thing is certain: the pressure to reduce deficits will push the eurozone into prolonged recession. This will have incalculable political consequences. The euro crisis could endanger the political cohesion of the European Union.

There is no escape from this gloomy scenario as long as the authorities persist in their current course. They could, however, change course. They could recognize that they have reached the end of the road and take a radically different approach. Instead of acquiescing in the absence of a solution and trying to buy time, they could look for a solution first and then find a path leading to it. The path that leads to a solution has to be found in Germany, which, as the EU’s largest and highest-rated creditor country, has been thrust into the position of deciding the future of Europe. That is the approach I propose to explore.

To resolve a crisis in which the impossible becomes possible it is necessary to think about the unthinkable. To start with, it is imperative to prepare for the possibility of default and defection from the eurozone in the case of Greece, Portugal, and perhaps Ireland. To prevent a financial meltdown, four sets of measures would have to be taken. First, bank deposits have to be protected. If a euro deposited in a Greek bank would be lost to the depositor, a euro deposited in an Italian bank would then be worth less than one in a German or Dutch bank and there would be a run on the banks of other deficit countries. Second, some banks in the defaulting countries have to be kept functioning in order to keep the economy from breaking down. Third, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Fourth, the government bonds of the other deficit countries would have to be protected from contagion. The last two requirements would apply even if no country defaults.

All this would cost money. Under existing arrangements no more money is to be found and no new arrangements are allowed by the German Constitutional Court decision without the authorization of the Bundestag. There is no alternative but to give birth to the missing ingredient: a European treasury with the power to tax and therefore to borrow. This would require a new treaty, transforming the EFSF into a full-fledged treasury.

That would presuppose a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro or to abandon it. That is a mistake. The euro exists and the assets and liabilities of the financial system are so intermingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to contain. The longer it takes for the German public to realize this, the heavier the price they and the rest of the world will have to pay.

The question is whether the German public can be convinced of this argument. Angela Merkel may not be able to persuade her own coalition, but she could rely on the opposition. Having resolved the euro crisis, she would have less to fear from the next elections.

The fact that arrangements are made for the possible default or defection of three small countries does not mean that those countries would be abandoned. On the contrary, the possibility of an orderly default—paid for by the other eurozone countries and the IMF—would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle now threatening all of the eurozone’s deficit countries whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.

Leaving the euro would make it easier for them to regain competitiveness; but if they are willing to make the necessary sacrifices they could also stay in. In both cases, the EFSF would protect bank deposits and the IMF would help to recapitalize the banking system. That would help these countries to escape from the trap in which they currently find themselves. It would be against the best interests of the European Union to allow these countries to collapse and drag down the global banking system with them.

It is not for me to spell out the details of the new treaty; that has to be decided by the member countries. But the discussions ought to start right away because even under extreme pressure they will take a long time to conclude. Once the principle of setting up a European Treasury is agreed upon, the European Council could authorize the ECB to step into the breach, indemnifying the ECB in advance against risks to its solvency. That is the only way to forestall a possible financial meltdown and another Great Depression.

—September 15, 2011

China to 'liquidate' US Treasuries, not dollars

2011-09-16T01:56:00.000-07:00

By Ambrose Evans-Pritchard, The Telegraph

September 15th, 2011

The debt markets have been warned.

A key rate setter-for China's central bank let slip – or was it a slip? – that Beijing aims to run down its portfolio of US debt as soon as safely possible.
"The incremental parts of our of our foreign reserve holdings should be invested in physical assets," said Li Daokui at the World Economic Forum in the very rainy city of Dalian – former Port Arthur from Russian colonial days.

"We would like to buy stakes in Boeing, Intel, and Apple, and maybe we should invest in these types of companies in a proactive way."

"Once the US Treasury market stabilizes we can liquidate more of our holdings of Treasuries," he said.

To my knowledge, this is the first time that a top adviser to China's central bank has uttered the word "liquidate". Until now the policy has been to diversify slowly by investing the fresh $200bn accumulated each quarter into other currencies and assets – chiefly AAA euro debt from Germany, France and the hard core.

We don't know how much US debt is held by SAFE (State Administration of Foreign Exchange), the bank's FX arm. The figure is thought to be over $2.2 trillion.
The Chinese are clearly vexed with Washington, viewing the Fed's QE as a stealth default on US debt. Mr Li came close to calling America a basket case, saying the picture is far worse than when Ronald Reagan and Margaret Thatcher took over in the early 1980s.

Mr Li, one of three outside academics on China's MPC, described the debt deals on Capitol Hill as "just trying to by time", saying it will not be enough to stop America's "debt dynamic" turning dangerous.

Fair enough, but let us be clear: the reason China has accumulated the equivalent of 6pc of global GDP in reserves (like the US in the 1920s) is because it has held down its currency to gain market share. As Michael Pettis from Beijing University points out tirelessly, the mercantilist policy hollows out US industries and forces America to choose between debt bubbles or unemployment – or, of course, protectionism, though we are not there yet.

Until it abandons that core policy, it has to keep buying foreign assets and lots of dollars. The euro can absorb only so much – 800bn euros so far – before Europeans realize (the French already realize) that Chinese bond purchases are double edged, and the yen the Swissie can't absorb anything at all. (The governments are intervening to stop it). Besides, China has the same misgivings about euro debt as it does about dollar debt. Perhaps more so after Euroland's long-running soap opera.
So what Li Daokui said is not bad for the dollar as such. He said there is "$10 trillion" waiting to be invested in the US, if America will open its doors.

It is bad for bonds – or will be. The money will go into strategic land purchases all over the world, until the backlash erupts in earnest. It will go into equities, until Capitol Hill has a heart attack. It will go anywhere but debt.

Yet another reason to be careful of 10-year Treasuries and Bunds below 2pc yields. There is a big seller out there, just itching to let go.

Default now or suffer a more expensive crisis later

2011-07-24T06:54:00.001-07:00

By Ron Paul

23 Jul 2011

Debate over the debt ceiling has reached a fever pitch in recent weeks, with each side trying to outdo the other in a game of political chicken. If you believe some of the things that are being written, the world will come to an end if the U.S. defaults on even the tiniest portion of its debt.

In strict terms, the default being discussed will occur if the U.S. fails to meet its debt obligations, through failure to pay either interest or principal due a bondholder. Proponents of raising the debt ceiling claim that a default on Aug. 2 is unprecedented and will result in calamity (never mind that this is simply an arbitrary date, easily changed, marking a congressional recess). My expectations of such a scenario are more sanguine.

The U.S. government defaulted at least three times on its obligations during the 20th century.

-- In 1934, the government banned ownership of gold and eliminated the right to exchange gold certificates for gold coins. It then immediately revalued gold from $20.67 per troy ounce to $35, thus devaluing the dollar holdings of all Americans by 40 percent.

-- From 1934 to 1968, the federal government continued to issue and redeem silver certificates, notes that circulated as legal tender that could be redeemed for silver coins or silver bars. In 1968, Congress unilaterally reneged on this obligation, too.

-- From 1934 to 1971, foreign governments were permitted by the U.S. government to exchange their dollars for gold through the gold window. In 1971, President Richard Nixon severed this final link between the dollar and gold by closing the gold window, thus in effect defaulting once again on a debt obligation of the U.S. government.

Unlimited Spending

No longer constrained by any sort of commodity backing, the federal government was now free to engage in almost unlimited fiscal profligacy, the only check on its spending being the market’s appetite for Treasury debt. Despite the defaults in 1934, 1968 and 1971, world markets have been only too willing to purchase Treasury debt and thereby fund the government’s deficit spending. If these major defaults didn’t result in decreased investor appetite for U.S. obligations, I see no reason why defaulting on a small amount of debt this August would cause any major changes.

The national debt now stands at just over $14 trillion, while net total liabilities are estimated at over $200 trillion. The government is insolvent, as there is no way that this massive sum of liabilities can ever be paid off. Successive Congresses and administrations have shown absolutely no restraint when it comes to the budget process, and the idea that either of the two parties is serious about getting our fiscal house in order is laughable.

Boom and Bust

The Austrian School’s theory of the business cycle describes how loose central bank monetary policy causes booms and busts: It drives down interest rates below the market rate, lowering the cost of borrowing; encourages malinvestment; and causes economic miscalculation as resources are diverted from the highest value use as reflected in true consumer preferences. Loose monetary policy caused the dot-com bubble and the housing bubble, and now is causing the government debt bubble.

For far too long, the Federal Reserve’s monetary policy and quantitative easing have kept interest rates artificially low, enabling the government to drastically increase its spending by funding its profligacy through new debt whose service costs were lower than they otherwise would have been.

Neither Republicans nor Democrats sought to end this gravy train, with one party prioritizing war spending and the other prioritizing welfare spending, and with both supporting both types of spending. But now, with the end of the second round of quantitative easing, the federal funds rate at the zero bound, and the debt limit maxed out, Congress finds itself in a real quandary.

Hard Decisions

It isn’t too late to return to fiscal sanity. We could start by canceling out the debt held by the Federal Reserve, which would clear $1.6 trillion under the debt ceiling. Or we could cut trillions of dollars in spending by bringing our troops home from overseas, making gradual reforms to Social Security and Medicare, and bringing the federal government back within the limits envisioned by the Constitution. Yet no one is willing to step up to the plate and make the hard decisions that are necessary. Everyone wants to kick the can down the road and believe that deficit spending can continue unabated.

Unless major changes are made today, the U.S. will default on its debt sooner or later, and it is certainly preferable that it be sooner rather than later.

If the government defaults on its debt now, the consequences undoubtedly will be painful in the short term. The loss of its AAA rating will raise the cost of issuing new debt, but this is not altogether a bad thing. Higher borrowing costs will ensure that the government cannot continue the same old spending policies. Budgets will have to be brought into balance (as the cost of servicing debt will be so expensive as to preclude future debt financing of government operations), so hopefully, in the long term, the government will return to sound financial footing.

Raising the Ceiling

The alternative to defaulting now is to keep increasing the debt ceiling, keep spending like a drunken sailor, and hope that the default comes after we die. A future default won’t take the form of a missed payment, but rather will come through hyperinflation. The already incestuous relationship between the Federal Reserve and the Treasury will grow even closer as the Fed begins to purchase debt directly from the Treasury and monetizes debt on a scale that makes QE2 look like a drop in the bucket. Imagine the societal breakdown of Weimar Germany, but in a country five times as large. That is what we face if we do not come to terms with our debt problem immediately.

Default will be painful, but it is all but inevitable for a country as heavily indebted as the U.S. Just as pumping money into the system to combat a recession only ensures an unsustainable economic boom and a future recession worse than the first, so too does continuously raising the debt ceiling only forestall the day of reckoning and ensure that, when it comes, it will be cataclysmic.

We have a choice: default now and take our medicine, or put it off as long as possible, when the effects will be much worse.

(Ron Paul is a Republican representative from Texas and a candidate for the 2012 Republican presidential nomination. The opinions expressed are his own.)

Mastering The Machine

2011-07-20T18:02:00.000-07:00

How Ray Dalio built the world’s richest and strangest hedge fund.

By John Cassidy

July 25, 2011

Ray Dalio, the sixty-one-year-old founder of Bridgewater Associates, the world’s biggest hedge fund, is tall and somewhat gaunt, with an expressive, lined face, gray-blue eyes, and longish gray hair that he parts on the left side. When I met him earlier this year at his office, on the outskirts of Westport, Connecticut, he was wearing an open-necked blue shirt, gray corduroy pants, and black leather boots. He looked a bit like an aging member of a British progressive-rock group. After a few pleasantries, he grabbed a thick briefing book and shepherded me into a large conference room, where his firm was holding what he described as its weekly “What’s going on in the world?” meeting.

Of the fifty or so people present, most were clean-cut men in their twenties or thirties. Dalio sat down near the front of the room. A colleague began describing how the European Central Bank had just bought some Greek bonds from investors at a discount to their face value—a move that the speaker described as a possible precursor to an over-all restructuring of Greece’s vast debts. Dalio interrupted him. He said, “Here’s where you are being imprecise,” and then explained at length what a proper debt restructuring would entail, dismissing the E.C.B.’s move as an exer-cise in “kicking it down the road.”

Dalio is a “macro” investor, which means that he bets mainly on economic trends, such as changes in exchange rates, inflation, and G.D.P. growth. In search of profitable opportunities, Bridgewater buys and sells more than a hundred different financial instruments around the world—from Japanese bonds to copper futures traded in London to Brazilian currency contracts—which explains why it keeps a close eye on Greece. In 2007, Dalio predicted that the housing-and-lending boom would end badly. Later that year, he warned the Bush Administration that many of the world’s largest banks were on the verge of insolvency. In 2008, a disastrous year for many of Bridgewater’s rivals, the firm’s flagship Pure Alpha fund rose in value by nine and a half per cent after accounting for fees. Last year, the Pure Alpha fund rose forty-five per cent, the highest re-turn of any big hedge fund. This year, it is again doing very well.

The discussion in the conference room moved on to Spain, the United Kingdom, and China, where, during the previous week, the central bank had raised interest rates in an attempt to slow inflation. Dalio said that the Chinese economy was in danger of overheating, and somebody asked how a Chinese slowdown would affect the price of oil and other commodities. Greg Jensen, Bridgewater’s co-chief executive and co-chief investment officer, who is thirty-six, said he thought that even a stuttering China would still grow fast enough to push world commodity prices upward.

Dalio asked for another opinion. From the back of the room, a young man dressed in a black sweatshirt started saying that a Chinese slowdown could have a big effect on global supply and demand. Dalio cut him off: “Are you going to answer me knowledgeably or are you going to give me a guess?” The young man, whom I will call Jack, said he would hazard an educated guess. “Don’t do that,” Dalio said. He went on, “You have a tendency to do this. . . . We’ve talked about this before.” After an awkward silence, Jack tried to defend himself, saying that he thought he had been asked to give his views. Dalio didn’t let up. Eventually, the young employee said that he would go away and do some careful calculations.

After the meeting, Dalio told me that the exchange had been typical for Bridgewater, where he encourages people to challenge one another’s views, regardless of rank, in what he calls a culture of “radical transparency.” Dalio had no qualms about upbraiding a junior employee in front of me and dozens of his colleagues. When confusions arise, he said, it is important to discuss them openly, even if that involves publicly pointing out people’s mistakes—a process he referred to as “getting in synch.” He added, “I believe that the biggest problem that humanity faces is an ego sensitivity to finding out whether one is right or wrong and identifying what one’s strengths and weaknesses are.”

Dalio is rich—preposterously rich. Last year alone, he earned between two and three billion dol-lars, and reached No. 55 on the Forbes 400 list. But what distinguishes him more from other hedge-fund managers is the depth of his economic analysis and the pretensions of his intellectual ambition. He is very keen to be seen as something more than a billionaire trader. Indeed, like his sometime rival George Soros, he appears to aspire to the role of worldly philosopher. In October, 2008, at the height of the financial crisis, he circulated a twenty-page essay immodestly titled “A Template for Understanding What’s Going On,” which said the economy faced not just a common recession but a “deleveraging”—a period in which people cut back on borrowing and rebuild their savings—the impact of which would be felt for a generation. This line of analysis wasn’t unique to Dalio, but almost three years later, with economic growth stagnating again, it does not seem off the mark.

Many hedge-fund managers stay pinned to their computer screens day and night monitoring movements in the markets. Dalio is different. He spends most of his time trying to figure out how economic and financial events fit together in a coherent framework. “Almost everything is like a machine,” he told me one day when he was rambling on, as he often does. “Nature is a machine. The family is a machine. The life cycle is like a machine.” His constant goal, he said, was to un-derstand how the economic machine works. “And then everything else I basically view as just a case at hand. So how does the machine work that you have a financial crisis? How does delever-aging work—what is the nature of that machine? And what is human nature, and how do you raise a community of people to run a business?”

Dalio is serenely convinced that the precepts he relies on in the markets can be applied to other aspects of life, such as career development and management. And he has enough regard for his own views on these subjects to have collected them in print. Before our meeting, he sent me a copy of his “Principles,” a hundred-page text that is required reading for Bridgewater’s new hires. It turned out to be partly a self-help book, partly a management manual, and partly a treatise on the principles of natural selection as they apply to business. “I believe that all successful people operate by principles that help them be successful,” a passage on the second page said. The text was organized into three sections: “5 Steps to Personal Evolution,” “10 Steps to Personal Deci-sion-Making,” and “Management Principles.” The last of the two hundred and seventy-seven management principles was: “Constantly worry about what you are missing. Even if you ac-knowledge you are a ‘dumb shit’ and are following the principles and are designing around your weaknesses, understand that you might still be missing things. You will be better and be safer this way.”

Dalio’s philosophy has created a workplace that some call creepy. Last year, Dealbreaker, a Wall Street Web site, picked up a copy of the Principles and made fun of a section in which Dalio appeared to compare Bridgewater to a pack of hyenas feeding on a young wildebeest. In March, AR, a magazine that covers hedge funds, quoted a former colleague of Dalio’s saying, “Bridgewater is a cult. It’s isolated, it has a charismatic leader and it has its own dogma.” The au-thors of the article noted that Dalio’s “emphasis on tearing down an individual’s ego hints at the so-called struggle groups of Maoism,” while his search for “human perfection devoid of emotion resembles the fantasy world in Ayn Rand’s ‘The Fountainhead.’”

Dalio doesn’t pretend that Bridgewater is a typical workplace, but he is sensitive to criticism. The recent media attention irked him, because, in his view, it misrepresented and trivialized Bridgewater’s culture, which he insists is central to the firm’s success. “It is why we made money for our clients during the financial crisis when most others went over the cliff,” he wrote to me in an e-mail. “Our greatest power is that we know that we don’t know and we are open to being wrong and learning.”

After the “What’s going on in the world?” meeting, he walked back to his office, an airy but modest-sized corner space that overlooks the Saugatuck River and is lined with pictures of his wife and four sons. He sat down behind his desk and showed me a book he had been reading—“Einstein’s Mistakes: The Human Failings of Genius,” by Hans C. Ohanian. “Here was the great-est mind of the twentieth century, and he made lots of mistakes,” Dalio said. In his Principles, Dalio declares that acknowledging errors, studying them, and learning from them is the key to success. He writes, “Pain + Reflection = Progress.” Bridgewater puts this equation into action by organizing lengthy assessment sessions, in which employees must discuss their mistakes.

The next item on Dalio’s agenda was a meeting with his two co-chief executives: Jensen and David McCormick, a former senior official in the Treasury Department under George W. Bush. Like virtually all meetings at Bridgewater, this one was taped. Dalio says that the tapes—some audio, some video—provide an objective record of what has been said; they can be used for train-ing purposes, and they allow Bridgewater’s employees to keep up with what is going on at the firm, including his discussions with senior colleagues. “They get to see all of my mistakes,” Dalio told me. “They get to see all of my humanity.”

Once a tape recorder had been switched on, Jensen, McCormick, and Dalio discussed the pos-sible promotion of an internal candidate to a senior-management role. McCormick, a soft-spoken forty-five-year-old who studied engineering at West Point, argued that the candidate’s prior ex-perience at a big Wall Street firm indicated that he could probably do the job. Dalio disagreed. An investment bank is a “totally different world,” he said. But, rather than continue the discussion, he asked one of his assistants to call in the candidate. One rule of radical transparency is that Bridge-water employees refrain from saying behind a person’s back anything that they wouldn’t say to his face.

The man arrived and stood before Dalio’s desk. Dalio explained what the discussion was about and said, “I don’t imagine that you would be a good fit for the job.” The man took a seat, and Dalio and McCormick continued their discussion about his qualifications. The candidate ex-plained his experience on Wall Street and said he thought he could do the job well. Dalio leaned back in his chair, looking skeptical. The employee didn’t get the promotion.

The only child of Italian-American parents, Ray Dalio was born in Jackson Heights, Queens, in 1949. His father was a jazz musician who played the clarinet and saxophone at Manhattan jazz clubs such as the Copacabana; his mother was a homemaker. When Dalio was eight, the family bought a three-bedroom house in Manhasset, and enrolled Ray in the local public school. “I was a bad student,” he recalls. “I have a bad rote memory, and I didn’t like studying.” From the age of twelve, Dalio caddied at the nearby Links Golf Club, whose members included many Wall Street investors. Some of them gave Dalio tips. The first stock he purchased was Northeastern Airlines, which soon received a takeover offer. Its shares tripled. “I figured that this was an easy game,” Dalio said. By the time he started college, at a nearby campus of Long Island University, he had built up a stock portfolio worth several thousand dollars.

After signing up for some finance classes, he discovered that there were some topics he en-joyed studying. Transcendental meditation, which he took up following a trip to India by the Beatles, also helped his work habits. Most mornings before going to the office, he still meditates. Demonstrating his technique, he sat back in his office chair, closed his eyes, and clasped his hands in front of him. “It’s just a mental exercise in which you are clearing your mind,” he said. “Crea-tivity comes from open-mindedness and centeredness—seeing things in a nonemotionally charged way.”

After graduating, Dalio went to Harvard Business School, where he traded commodities—grains, oil, cotton, and so on—for his own account. Not long after leaving Harvard, he landed at Shearson Hayden Stone, the brokerage firm run by Sanford Weill. Dalio worked in the commod-ity-futures department, advising cattle ranchers, grain producers, and others on how to hedge risks. (The horns of a longhorn steer, the gift of some California ranchers, are mounted behind his desk.) On New Year’s Eve in 1974, Dalio went out drinking with his departmental boss, got into a dis-agreement, and slugged him. About the same time, at the annual convention of the California Food & Grain Growers’ Association, he paid an exotic dancer to drop her cloak in front of the crowd. After being fired, he persuaded some of his clients to hire him as a consultant and founded Bridgewater, operating it out of his two-bedroom apartment. He was twenty-six years old.

By the early nineteen-eighties, Dalio had got married, started a family, and moved to Wilton, Connecticut, where he lived and traded out of a converted barn. He also advised businesses on how to manage risk and published an economic newsletter. One of his readers was Bob Prince, a young financial analyst who worked for a bank in Oklahoma, and who is now Bridgewater’s co-chief investment officer. Prince showed one of Dalio’s articles to his boss, David Moffett, who went on to become the chief executive of Freddie Mac. “He said it was the best thing he had ever read on how the economy works,” Prince recalled. Another of Dalio’s articles that stuck in Prince’s memory was titled “What Is a Jeweler?” It described a jeweller as basically an investor with a long position in gold and precious stones. If the market price of these commodities goes up, the jeweller makes money on his stock. If prices fall, he can lose out. To limit the risk, Dalio wrote that jewellers should purchase gold-futures contracts designed to rise in value when the price of gold falls.

In 1985, Dalio persuaded the World Bank’s employee-retirement fund to let Bridgewater man-age some of its capital. In 1989, Kodak’s retirement system did the same. At the time, Kodak had most of its money invested in stocks. Dalio’s pitch, which hasn’t changed much over the years, was that by investing in a variety of other markets, such as U.S. and international bonds, and us-ing leverage to bolster its exposure, Bridgewater could match or beat the stock market with less risk. “He had a new way of thinking,” Rusty Olson, who ran Kodak’s retirement funds for many years, told me. “You get the same return, but you get a heck of a lot of beneficial diversification, too.”

Hedge funds date to 1949, when Alfred Winslow Jones, a writer at Fortune, opened a private in-vestment firm using sixty thousand dollars he had raised from friends and forty thousand he had saved. To boost his returns, Jones borrowed heavily and bought stocks he liked “on margin”—a practice that had been discredited in the late nineteen-twenties. As a “hedge” against the market falling, Jones also picked out some stocks he believed to be overvalued and bet against them—a practice known as “selling short.” Jones’s fund regularly beat the Dow, and by the late nineteen-sixties it had attracted many imitators.

Worldwide, there are now some ten thousand hedge funds, which the government regulates only loosely. Together, they have about two trillion dollars under management. Even today, they employ the two basic tools that Jones used—borrowing (“leverage”) and selling short—and they charge their clients hefty fees, as Jones did. On top of a two-per-cent management fee, they de-duct twenty per cent of any investment gains they generate. Jones claimed that this remuneration scheme, which is known as “two and twenty,” was inspired by the way ancient Phoenician mer-chants financed their trading expeditions. But the practice is also tax-driven. It allows hedge-fund managers to classify much of their income as capital gains, which are taxed at a far lower rate than regular income. While cops and schoolteachers face a marginal tax rate of twenty-five per cent, hedge-fund managers like Dalio have for years paid fifteen per cent on the lion’s share of their income.

Some hedge-fund managers, such as Steven A. Cohen, of S.A.C. Capital, and David Einhorn, of Greenlight Capital, are stock pickers, like Jones. Others, such as James Simons, of Renaissance Technologies, are known as “quants.” They use computers to sift through market data, spot profit-able opportunities, and place trades, all with minimal human intervention. As a macro trader, Dalio is working in the tradition of George Soros and Julian Robertson, famous speculators who ranged across markets.
Bridgewater has long run two primary investment funds. One, called All Weather, has low charges attached to it and seeks to match the over-all market return, which is known as “beta,” in whichever market the client chooses. Another, Pure Alpha, which has the standard two-and-twenty charges, aims at beating the market return but also at limiting risk. To investment profes-sionals, “alpha” is the return over and above the market return. If in a given year the S. & P. 500 returns fifteen per cent and an equity-fund manager generates a return of twenty per cent, his al-pha is five per cent.

Part of Dalio’s innovation has been to build a hedge fund that caters principally to institutional investors rather than to rich individuals. Of the roughly one hundred billion dollars invested in Bridgewater, only a small proportion comes from wealthy families. Almost a third comes from public pension funds, such as the Pennsylvania Public School Employees’ Retirement System; another third comes from corporate pension funds, such as those at Kodak and General Motors; a quarter comes from government-run sovereign wealth funds, such as the Government Investment Corporation of Singapore. “Making money on a constant basis is the holy grail, and Ray and Bridgewater have done that,” Ng Kok-Song, the chief investment officer of the Singapore fund, told me. “They are consistently innovating—constantly soul-searching and asking, ‘Have we got this right?’ ” Kok-Song went on, “I am constantly asking myself, ‘If Bridgewater is doing this, shouldn’t we be doing the same thing?’ ”
At some hedge funds, client service is an afterthought. Bridgewater’s investors receive a daily newsletter, monthly performance updates, quarterly reviews, and conference-call briefings from Dalio and other senior executives. “When a lot of folks were very, very secretive, Ray could see the value in creating something that was more open, something that was attractive to very large streams of money,” Robert Johnson, a former senior executive at Soros Fund Management, who now runs the Institute for New Economic Thinking, said to me.

Recently, the hedge-fund industry has been shaken by allegations that it exploits inside infor-mation. In May, Raj Rajaratnam, the founder of the Galleon Group, was convicted on fourteen counts of conspiracy and securities fraud. Other government investigations are continuing, includ-ing one involving S.A.C. Capital. Dalio and Bridgewater don’t appear to be involved. Dalio told me that Bridgewater hasn’t received any subpoenas, adding that he had no reason to believe that the firm was under investigation by any official agency.
Dalio is an outdoorsman and naturalist of the Hemingway school: he likes to go places and kill things. He fishes in Canada, shoots grouse in Scotland, and hunts big game in Africa, with a bow—particularly Cape buffalo, which weigh up to two thousand pounds, are famously ornery, and sometimes gore hunters with their giant horns. Naturally, Dalio sees this as a metaphor for how he invests. “It’s always a matter of controlling risk,” he explained. “Risky things are not in themselves risky if you understand them and control them. If you do it randomly and you are sloppy about it, it can be very risky.” The key to success, he said, is figuring out “Where is the edge? And how do I stay the right distance from the edge?”

One way he does it is by spreading his bets: at any given time, the Pure Alpha fund typically has in place about thirty or forty different trades. “I’m always trying to figure out my probability of knowing,” Dalio said. “Given that I’m never sure, I don’t want to have any concentrated bets.” Such thinking runs counter to the conventional wisdom in the hedge-fund industry, which is that the only way to score big is to bet the house. George Soros famously did this in 1992—selling short some ten billion dollars’ worth of sterling. A few years ago, John Paulson wagered hugely against U.S. mortgage bonds and made several billion dollars.

Dalio is a consistent hitter of singles and doubles—the José Reyes of Wall Street. Among the bets the Pure Alpha fund placed last year were long positions in Treasury bonds, the Japanese yen, and gold, and short positions in the euro and European sovereign debt. A potential problem with this type of global investing is that these days many markets move in the same direction, which makes it hard to achieve real diversification. Bridgewater’s solution is to place a lot of “spread” bets, purchasing one security it considers undervalued and selling short another one it considers overvalued. For example, it might buy platinum and sell silver, or buy a thirty-year U.K. bond and sell a ten-year bond. The returns from spread bets tend to be uncorrelated with the over-all market.

Other hedge funds have tried to mimic Dalio’s approach, which is sometimes referred to as “portable alpha,” but none have proved as successful. The strategy depends on an ability to out-perform the market consistently, which many economists regard as virtually impossible. Dalio somehow seems to manage it.

At the start of the year, Bridgewater turned bearish on U.S. bonds and built up a short position. When the bond market stumbled, this bet (which the firm has since reversed) paid off handsomely, as did wagers on commodities and emerging-market currencies. So far in 2011, while the average hedge fund has struggled to make any money at all, the Pure Alpha fund is up more than ten per cent. The bet against Treasuries gave the lie to a criticism sometimes made of Dalio—that he is basically a bond-market investor, who has benefitted from a twenty-year rally in bonds. “We have been equally likely to be short bonds or long bonds,” he said. “The performance of the Pure Alpha fund is not correlated with any asset class or any market. It has done equally well in any environment.”

What accounts for Dalio’s success? His colleague Bob Prince describes him as “a big-picture thinker connected to a street-smart” trader. Many economists start at the top and work down. They look at aggregate statistics—inflation, unemployment, the money supply—and figure out what the numbers mean for particular industries, such as autos or tech. Dalio does things the other way around. In any market that interests him, he identifies the buyers and sellers, estimates how much they are likely to demand and supply, and then looks at whether his findings are already reflected in the market price. If not, there may be money to be made. In the U.S. bond market, Bridgewater scrutinizes the weekly U.S. Treasury auctions to see who is buying—American banks, foreign central banks, mutual funds, pension funds, rival hedge funds—and who isn’t. In the commodities markets, the firm goes through a similar exercise, trying to figure out how much demand is com-ing from corporations and how much from speculators. “It all comes down to who is going to buy and who is going to sell and for what reasons,” Dalio explained.

To guide its investments, Bridgewater has put together hundreds of “decision rules.” These are the financial analogue of Dalio’s Principles. He used to write them down and keep them in a ring binder. Today, they are encoded in Bridgewater’s computers. Some of these indicators are very general. One of them says that if inflation-adjusted interest rates decline in a given country, its currency is likely to decline. Others are more specific. One says that, over the long run, the price of gold approximates the total amount of money in circulation divided by the size of the gold stock. If the market price of gold moves a long way from this level, it may indicate a buying or selling opportunity.

In any given market, Bridgewater may have a dozen or more different indicators. However, even when most or all of the indicators are pointing in a certain direction, Dalio doesn’t rely solely on software. Unless he and Jensen and Prince agree that a certain trade makes sense, the firm doesn’t make it. While this inevitably introduces an element of human judgment to the in-vestment process, Dalio insists it is still driven by the rules-based framework he has built up over thirty years. “When I’m thinking, ‘What is going on today?,’ I also need to make the connection to ‘How does what is happening today fit into our framework for making this decision?’ ’’ he said. Ultimately, he says, it is the commitment to systematic analysis and systematic investment that distinguishes Bridgewater from other hedge funds. “I hear a lot of people describing what’s hap-pening today without the proper historical context and without the framework of how the machine works,” he says.

In looking at the economy as a whole, Dalio pays particular attention to the amount of credit that banks and other financial institutions are creating, which he regards as a key factor in over-all spending. This may seem like common sense, but until recently many economists and policymak-ers didn’t pay much heed to the growth of credit, concentrating instead on the amount of actual money in the economy—notes, coins, bank deposits—which is largely determined by the Federal Reserve. In July, 2007, Dalio and a co-author wrote in Bridgewater’s daily newsletter about “crazy lending and leveraging practices,” adding, “We want to avoid or fade this lunacy.” A couple of weeks later, after the subprime-mortgage market froze up, Dalio’s newsletter declared, “This is the financial market unraveling we have been expecting. . . . This will run through the system with the speed of a hurricane.”

Searching for historical precedents, Bridgewater put together detailed histories of previous credit crises, going back to Weimar Germany. The firm’s researchers also went through the public accounts of nearly all the major financial institutions in the world and constructed estimates of how much money they stood to lose from bad debts. The figure they came up with was eight hun-dred and thirty-nine billion dollars. Armed with this information, Dalio visited the Treasury De-partment in December, 2007, and met with some of Treasury Secretary Henry Paulson’s staff. Nobody took much notice of what he said, but he went on to the White House, where he presented his numbers to some senior economic staffers. “Ray laid out the argument that the losses he fore-saw in the banking system were astronomical,” a former Bush Administration official who at-tended the White House meeting recalled. “Everybody else was talking about liquidity. Ray was talking about solvency.”

His warnings ignored in Washington, Dalio issued more jeremiads to his clients. “If the econ-omy goes down, it will not be a typical recession,” his newsletter said in January, 2008. Rather, it would be a disaster in which “the financial deleveraging causes a financial crisis that causes an economic crisis. . . . This continues until there is a reflation, a currency devaluation and govern-ment guarantees of the efficacy of key financial intermediaries.” As the crisis deepened, Dalio continued to assess it far more accurately than many senior policymakers did. When the govern-ment allowed Lehman Brothers to collapse, he despaired. “So, now we sit and wait to see if they have some hidden trick up their sleeves, or if they really are as reckless as they seem,” the news-letter said on September 15, 2008.

Eventually, after the near implosion of the financial system had brought about a deep recession, some policymakers came to respect Dalio’s analysis. “I think the central policy judgment was that there was more risk in doing too little than in doing too much,” Lawrence Summers, who headed the National Economic Council between 2009 and 2010, recalled. “That was a judgment I reached, and it was a judgment Ray reached.” While Summers was in the White House, he read Bridge-water’s economic newsletter and spoke every few months with Dalio, whom he described to me as “an impressively intellectually aggressive guy.” Summers went on, “He had a fully articulated way of looking at the economy. I’m not sure I would agree with all of it, but it seems to have been a very powerful analytical tool through this particular period.”
And a powerful investment tool, too. Anticipating that the Federal Reserve would be forced to print a lot of money to revive the economy, Bridgewater placed a number of bets that would pay off in such a scenario—for instance, going long Treasury bonds, shorting the dollar, and buying gold and other commodities. These trades helped the Pure Alpha fund make money in 2008, but Dalio’s bearishness cost him in 2009. Despite the Fed’s actions and the Obama Administration’s stimulus package, Dalio predicted that the economic recovery would be weak. When growth re-bounded faster than he expected and the Dow rose nineteen per cent, the Pure Alpha fund gained just four per cent. But last year, when G.D.P. growth faltered, the fund made a great deal of money betting on Treasury bonds and other securities that tend to do well in a weak economy.

In April, an article in New York ridiculed Dalio’s Principles, saying that they read “as if Ayn Rand and Deepak Chopra had collaborated on a line of fortune cookies.” It also accused him of running Bridgewater like a cult. “I’ve been surprised that there’s been so much controversy about us hav-ing such clearly set-out principles, especially since they’re all about being truthful and transparent to do good work and have meaningful relationships,” Dalio wrote to me subsequently. “Most of the people who don’t like us having them haven’t read them—they just assume that us having a lot of principles makes us a cult. That’s O.K. I figure that the people who matter to us will take the time to read them and form their own opinions and those who don’t care enough to read them don’t matter to us.”

Dalio may protest too much. The word “cult” clearly has connotations that don’t apply to an enterprise staffed by highly paid employees who can quit at any moment. But Bridgewater’s headquarters are in the woods, isolated from any other financial institution; Dalio is a strong-willed leader; and the employees do use their own vocabulary—Dalio’s vocabulary. Bob Elliott, a twenty-nine-year-old Harvard graduate who has worked at Bridgewater for six years, told me ear-nestly, “Once you understand how the machine works, you have the ability to take that and study and apply it across markets.” It’s also the case that in the time I spent at the firm I saw senior people criticizing subordinates—but not the reverse.

In his Principles, Dalio acknowledged that his firm can seem strange to outsiders and newcomers: “Since Bridgewater’s culture is very different from what is typical in the world at large, peo-ple often encounter culture shock when they start here.” In part to minimize this shock, for years Bridgewater recruited young men and women straight out of college. (Harvard, Princeton, and Dartmouth were favorite targets.) But the firm’s in-your-face attitude—and the relentless pressure to perform—takes its toll. “We get a lot of people who self-select out of that pretty quickly,” Mi-chael Partington, a recruiter at Bridgewater, said to me. Within two years of arriving at Bridge-water, about a quarter of new hires have quit or been let go.

Bridgewater has been expanding rapidly—it now has more than a thousand people on its pay-roll—and it has brought in a lot of mid-career executives. One day, I drove to Westport and sat in on a management-committee meeting, which had been set up for the purpose of “getting in synch” with a recent recruit, whom I’ll call Peter and who had come from a big financial firm. All nine members of Bridgewater’s management committee were sitting at a long wooden conference table. Peter, a lean man with fair hair, sat stiffly near the front: he looked like somebody anticipating a root canal. Jensen and McCormick were nominally in charge, but Dalio took over, telling Peter that, during a previous management meeting, he had answered emotionally in response to ques-tioning from Jensen. “This is a common thing when somebody’s getting probed,” Dalio said. “Because the amygdala gets stimulated and you have that emotional reaction.” Peter agreed that he had become upset, especially when he sensed he was being accused of misleading his colleagues. “I felt in some sense my integrity was being attacked,” he said. “That’s when things spiralled out of control.”

Dalio walked to the front of the room, where he wrote on a whiteboard, “FELT,” “INTEGRITY,” and “MISLED.” “?‘Felt’ is the key word here . . . and it’s a challenge for people,” he said. After a bit more discussion, he went on, “What we’re trying to have is a place where there are no ego bar-riers, no emotional reactions to mistakes. . . . If we could eliminate all those reactions, we’d learn so much faster.” Another member of the committee, Eileen Murray, intervened to say she as-sumed that Peter had not encountered this type of conversation at his previous job. He confirmed that he hadn’t. Murray nodded sympathetically. “When I first came here, I was like, ‘What the hell is going on?’ ” she said.

Dalio wasn’t finished. He suggested that the problem was that Peter had an idea of how things should be handled, and when the reality turned out to be different he hadn’t been honest with his colleagues. “The issue is that you are not freely releasing those beliefs,” he said to Peter. “Unlike a lot of companies, where you are meant to sit there and be quiet . . . here we respect your notion that you have a point of view. . . . Your responsibility is to say, ‘Does it make sense to me?’ And if it doesn’t make sense don’t keep it bottled up.” Dalio went on, “I’m saying, just let it flow, man.”

Peter said he thought it was understandable that somebody new to the firm would react under stress as he had. Still, he added, “If I had to replay this thing again, I’d be much more open with my thoughts.”

“What would you say the duty of a leader is?” Dalio asked him.

Peter replied, “The duty of a leader, first and foremost, is to be transparent.”

Bridgewater’s decision rules surely contribute to his firm’s success. But Dalio also believes that his management principles play a role. “What is a typical organization?” he asked me one day. “A typical organization is one where people are walking around saying, ‘This is stupid, this doesn’t make sense,’ behind each other’s backs.” In support of his management theories, Dalio has an ex-pert witness. “About eighty-five per cent of what’s in the Principles could be documented and supported by research,” Bob Eichinger, an organizational psychologist who has done consulting work for Bridgewater and other large companies, said. Eichinger went on, “Is it a better way to run a company? From a results perspective, probably so. Could a large portion of the working population be comfortable in that environment? Probably not.”

Some senior executives at Bridgewater do relish working there. Eileen Murray, who runs the firm’s accounting and technology systems, is one of them. Before moving to Bridgewater, in 2009, she spent twenty-five years on Wall Street, rising to a senior post at Morgan Stanley. “I wanted to make sure I wasn’t joining some petri dish in Westport, Connecticut, as part of a big experiment,” she said, recalling her initial, lengthy conversations with Dalio. “If someone’s intention is to make me a better person, I really appreciate that. If people do things because they can, or because they are the boss . . . I don’t react to that well.” Murray said she is now reassured, because “the inten-tion is to make people better. . . . I have never seen a C.E.O. spend as much time developing his people as Ray.”

Another new member of Bridgewater’s management committee is James Comey, the firm’s top lawyer, who served as Deputy Attorney General in the Bush Administration between 2003 and 2005. “Most of my friends think I am having a midlife crisis,” Comey told me in a recent phone conversation, referring to his decision, last year, to leave Lockheed Martin and accept an offer from Dalio. He was tired of corporate politics and craved a setting where people spoke truth to power, but, he said, it took him a while to get used to dealing with Dalio. “When Ray sent me an e-mail saying, ‘I think what you said today doesn’t make sense,’ I tended to think, What does he really mean? Where’s he coming from? And what is my play? Who are my allies? All of the things you think about in the outside world. It took me three months to realize that when Ray says, ‘I think you are wrong,’ he really means ‘I think you are wrong.’ He’s not trying to provoke you, or anything else.”

Comey was initially struck by how long it took Bridgewater to make decisions, because of the ceaseless internal debates. “I said, ‘Lordy, we have to put tops on bottoms. Let’s get something done,’ ” Comey recalled. But he added, laughing, “The mind control is working. I’ve come to be-lieve that all the probing actually reduces inefficiencies over the long run, because it prevents bad decisions from being made.” Comey said of Dalio, “He’s tough and he’s demanding and some-times he talks too much, but, God, is he a smart bastard.”

And yet Dalio’s acuity prompts an awkward question: how much of Bridgewater’s success comes not from the way it is organized, or any notion of “radical transparency,” but from the boss’s raw investment abilities? At other hedge funds, it is taken for granted that the firm’s prin-cipal asset walks out the door every evening and settles into a chauffeur-driven car. Is Bridge-water really any different? Although the firm trades in more than a hundred markets, it is widely believed that the great bulk of its profit comes from two areas in which Dalio is an expert: the bond and currency markets of major industrial countries. Unlike some other hedge funds, Bridge-water has never made much money in the U.S. stock market, an area where Dalio has less experi-ence. “Bridgewater really is Ray,” one former employee told me. “The key decisions they have made—where they have really made their money—is Ray. Most of what really matters is Ray, with help from Greg and Bob. You could run the firm with forty or fifty people instead of a thou-sand, and it would be basically the same.”

As long as Dalio remains healthy, the fact that he plays a key role in directing Bridgewater’s investments isn’t an issue. (Based on past experience, it is a big advantage.) But, from a business and marketing perspective, the suggestion that Bridgewater’s success continues to hinge on Dalio is a problematic one. As the former employee explained, “It’s hard to market that model—one guy and his brilliant track record. If you want to sell your firm to institutional clients, it’s critical to appear to be ‘rule-driven.’ That takes a lot of smarts. Most people want to take the credit. To say ‘I just run this machine’ detracts from your own individual brilliance. But that is very smart business.”

Dalio contests this account. He insists that he is but one member of a large team, with Greg Jensen and Bob Prince acting as his co-chief investment officers. He compares the comments of former employees to the carping of ex-spouses. In fact, with the firm prospering, Dalio has been living up to a promise to spend a bit more time away from it, and he has ceded some day-to-day manage-ment responsibility to Jensen and McCormick. “I’m stepping back a little: I’m going to a minister/mentor role,” Dalio said, comparing himself to Lee Kuan Yew, the longtime Prime Minister of Singapore, who relinquished his post in 1990 but even today retains great influence.

This month, Dalio is formally giving up his co-C.E.O. title in favor of “Mentor.”
The managerial changes and Dalio’s lean appearance have ignited some speculation that he is sick, but he insisted to me that he is fine. He said his weight loss was the result of an “intended weight-loss program,” and he said he has absolutely no intention of giving up his role in directing Bridgewater’s investments. In stepping back from day-to-day management and in bringing in sen-ior people, he said he is seeking to preserve the essence of the firm he built while preparing it for his eventual departure. Bridgewater has grown so large that its two main funds are now closed to new investors. Recently it launched a third fund, which is called Pure Alpha Major Markets.

Last year, Dalio sold about twenty per cent of Bridgewater to some of its employees in a deal financed by several of the firm’s longtime clients, and he told me that ultimately he would like to sell his entire ownership stake to his colleagues. Unlike certain other hedge-fund managers, though, he has no interest in making another fortune by floating his firm on the stock market. “I don’t want Bridgewater to go public or have it controlled by anybody outside the firm,” he said. “I think people who do that tend to mess up the firm.”

Dalio insists that money has never been his main motivation. He lives well, but avoids the con-spicuous consumption that some of his rivals indulge in. He and his wife, Barbara, to whom he has been married for thirty-four years, own two houses, one in Greenwich, Connecticut, and one in Greenwich Village, which he sometimes uses on weekends. (They are currently building a new house on the water in Connecticut.) Apart from hunting and exploring remote areas, Dalio’s main hobby is music: jazz, blues, and rock and roll. Recently, he joined a philanthropic campaign started by Bill Gates and Warren Buffett, pledging to give away at least half of his money. (Forbes estimates his net worth at six billion dollars.) He and his wife wrote in a public letter, “We learned that beyond having enough money to help secure the basics—quality relationships, health, stimulating ideas, etc.—having more money, while nice, wasn’t all that important.”

Not that Dalio makes any apology for his fortune or his profession. An agnostic and a self-described “hyperrealist,” he regards it as self-evident that all social systems obey nature’s laws, and that individual participants get rewarded or punished according to how far they operate in harmony with those laws. He views the financial markets as simply another social system, which determines payoffs and punishments in a like manner. “You have to be accurate,” he says. “Oth-erwise, you are going to pay. Alpha is zero sum. In order to earn more than the market return, you have to take money from somebody else.”

Dalio is right, but somewhat self-serving. If hedge-fund managers are playing a zero-sum game, what is their social utility? And if, as many critics contend, there isn’t any, how can they justify their vast remuneration? When I put these questions to Dalio, he insisted that, through pen-sion funds, Bridgewater’s investors include teachers and other public-sector workers, and that the firm created more value for its clients last year than Amazon, eBay, and Yahoo combined. How-ever, it is one thing to say that the most successful hedge-fund managers earn the riches they reap. It is quite another to suggest that the entire industry serves a social purpose. But that is Dalio’s contention. “In aggregate, it really contributes a lot to the efficiency of capital allocation, and capital allocation is very important,” he said.

Like many successful financiers, Dalio justifies capitalism and his place in it as a Darwinian process, in which the over-all logic of the system is sometimes hidden. This is actually what the mention, in his Principles, of hyenas savaging a wildebeest was about. “Is this good or bad?” he wrote. Like “death itself, this behavior is integral to the enormously complex and efficient system that has worked for as long as there has been life.” Of course, this view conveniently ignores the argument that hedge funds, through their herd behavior, have contributed to speculative bubbles, in tech stocks, oil, and other commodities. Even some defenders of the industry concede that the problem is real and potentially calamitous. “There is a basis for the argument that hedge funds add economic value,” Andrew Lo, an economist at M.I.T. who runs his own hedge fund, says. “At the same time, they create systemic risks that have to be weighed against those positives.”

Because hedge funds use a lot of borrowed money to magnify their bets, they are subject to rapid reversals: the history of the industry is littered with blowups. This wouldn’t matter much if other parts of the economy weren’t affected by the actions of hedge funds, but sometimes they are. In 2008, hedge funds had hundreds of billions of dollars on deposit at investment banks, which acted as their brokers and counterparties on many trades. When the Wall Street firms got into trouble, a number of other hedge funds demanded their money back immediately. These demands amounted to a virtual run on the banks and helped to bring down Bear Stearns and Lehman Broth-ers. Dalio acknowledged to me that Bridgewater was one of the funds that pulled a lot of money out of Lehman and other Wall Street firms, but he said he had little choice. “I’m a fiduciary to my clients. My responsibility is to know where it’s risky and where it’s not risky, and to get out of the risks.”

Hedge funds have also contributed to the radical increase in income inequality. Fifteen years ago on Wall Street, remuneration packages of five or ten million dollars a year were rare. Today, C.E.O.s and star traders routinely demand vastly higher sums to keep up with their counterparts at hedge funds. In addition to distorting salary structures elsewhere, the rewards that hedge-fund managers reap draw some of the very brightest science and mathematics graduates to the industry. Can it really be in America’s interest to have so much of its young talent playing a zero-sum game?

Rather than confronting these issues, Dalio, like all successful predators, is concentrating on the business at hand—the markets and the global economic outlook. This spring, he told me that economic growth in the United States and Europe was set to slow again. This was partly because some emergency policy measures, such as the Obama Administration’s stimulus package, would soon come to an end; partly because of the chronic indebtedness that continues to weigh on these regions; and partly because China and other developing countries would be forced to take drastic policy actions to bring down inflation. Now that the slowdown appears to have arrived, Dalio thinks it will be prolonged. “We are still in a deleveraging period,” he said. “We will be in a de-leveraging period for ten years or more.”

Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets. “There hasn’t been a case in history where they haven’t eventually printed money and devalued their currency,” he said. Other developed countries, particu-larly those tied to the euro and thus to the European Central Bank, don’t have the option of print-ing money and are destined to undergo “classic depressions,” Dalio said. The recent deal to avoid an immediate debt default by Greece didn’t alter his pessimistic view. “People concentrate on the particular thing of the moment, and they forget the larger underlying forces,” he said. “That’s what got us into the debt crisis. It’s just today, today.”

Dalio’s assessment sounded alarmingly plausible. But when one plays the global financial markets a thorough economic analysis is only the first stage of the game. At least as important is getting the timing right. I asked Dalio when all this would start to come together. “I think late 2012 or early 2013 is going to be another very difficult period,” he said.

Wendi Deng Murdoch — A Life

2011-07-20T17:53:00.000-07:00

"Cheers to Wendi! Gan bei! Drink the cup dry!"

It's 8 pm on a freezing night in Xuzhou, and we're having a jolly time in the Overflowing Fragrance dining room of the Sea Sky Holiday Hotel, an oddly named establishment given that this grim industrial city of 10 million people is 500 kilometres west of the Yellow Sea, and no place for a vacation.

We're toasting a thriving Chinese export, a girl born of modest means in nearby Shandong in December 1968 and given a politically correct name - Wen Ge, shorthand for ‘Cultural Revolution' - as was the imperative for parents in that dark era. And what a remarkable journey to celebrate: catapulting herself from the anonymity and austerity of communist China to the family, and the family trust, of one of the world's most powerful and wealthy men, and all this by the age of 30.

Given the heights that ‘Cultural Revolution' has effortlessly scaled - now 38, exactly half her husband's age, she is the mother of two potential heiresses and well positioned for the break-up of a US$70-billion media empire that's wrestling with a tortuous succession from patriarch to who-knows-where - Wendi Deng Murdoch's long march from China has actually been a rather short one; a Great Leap Forward to be sure, but not quite the one Mao had in mind.

I'm banqueting in Xuzhou with some of Wendi's old friends and mentors, who've shown me around her home town: her high-school volleyball coach, Wang Chongsheng; her then best friend, Li Hong; and Li's husband, a local policeman. Wendi's high-school supervisor, Xie Qidong, chatted with me earlier over tea. They're all open and welcoming, and we've become instant friends, gossiping over delicacies of beef, chicken, fish, abalone with the texture of a wetsuit, and delicious jiaozi dumplings. The arrival of the noodle course, symbolising longevity, prompts another round of toasts: "Long life to Wendi! Good luck to her!" Delegates from the National People's Congress in Beijing drone away on a TV, but no one takes any notice; we're too busy drinking Wendi's health.

"Gan bei! Drink the cup dry for Wendi!"

Deng Wen Ge - she changed her name to Wendi in her mid-teens - was born in Shandong around the time that her future husband was buying London's News of the World. One of three children, she grew up in neighbouring Xuzhou as a Subei ren - a vernacular term for the robust, rosy-cheeked folk of northern Jiangsu province, who are known, if not always loved, throughout China for being blunt, blithe and somewhat uncouth.

Today is ‘Learn From Lei Feng Day' in China, commemorating the People's Liberation Army soldier who was transformed by propaganda into a communist icon of selflessness, nobility and modesty. They're qualities that Wendi's supporters and detractors - and there are plenty of both in the Murdoch milieux - insist she either has in spades or lacks in equal measure. She elicits polarised views, as a browse through postings on the 250-odd Rupert-and-Wendi sites generously hosted on the Murdoch-owned MySpace website reveals. Does she genuinely love him, netizens ask, and he her? Or is their relationship defined by what they can provide each other, she lured by his money and power, and he smitten by her youth or her intoxicating proximity to China's media market, access to which he so covets but has failed to gain?

Many people regard Wendi as a Chinese Becky Sharp, and think that the infatuated Rupert, usually so cold and shrewd, so corporately clairvoyant, can't or won't see it. When Anna Nicole Smith died, for example, Private Eye published a picture of Wendi as a catsuit-clad dominatrix, with the caption, "Anna Nicole Deng: the scheming temptress who stole her way into the heart of a foolish old man - and stole all his money as well!" For all the Wendi sceptics, though, there are those who insist she's the best thing that could have happened to News Corporation, rejuvenating it and its ageing leader at the end of his reign. Says Wendi's close American friend Kathy Freston, the wife of the former Viacom executive Tom, "people say [Rupert] is lighter and happier since knowing her. He lights up when she walks in the room; they are very much a team, truly each other's confidante." A News executive remembers being on the company jet with Rupert and Wendi, watching the two entertain each other with Hollywood gossip and tattle. "It was like both of them had read People magazine cover to cover. They were loving it."

What has become clear as I've journeyed through Wendi's China - Beijing, where the Murdochs have reportedly paid US$5 million for a traditional siheyuan (four-walled courtyard) house in the shadow of the Forbidden City; Hong Kong, where she joined Murdoch's Star TV as an intern in 1996 and where she partied in the heady build-up to the colony's change of sovereignty; Xuzhou and Guangzhou, the austere towns of her childhood and youth - is that she's no princeling. Known as taizidang, princelings are China's Red Aristocracy: the in?uence-broking offspring of Communist Party grandees who advise investment banks or glad-hand foreign joint ventures. Many around News Corporation - usually those without Sino sensibilities - believe that Wendi has similarly superb connections in Beijing, possessing the means to deliver China's 1.3 billion consumers to a company that thus far has made myriad blunders and only glacial progress in trying to reach them. But in Xuzhou, high-school supervisor Xie Qidong, who knew the Deng family well, says that Wendi's father was just a medium-level party official, at best, in the state ironworks. "He was an engineer," Xie remembers. "One could not be a big guy coming from a machinery works at that time."

If Wendi is known in China, then, it is as the Mandarin-speaking wife of a powerful Western businessman, who acts as his quasi-ambassador, handing around a business card that says simply "Wendi Deng Murdoch, News Corporation" and assuming that the Communist Party heavies whom her husband needs to get onside will recognise the surname. But even if they do, there's no certainty that they will be much help. Murdoch has power in the West largely because he operates in democracies which allow him influence; China is a rigid one-party state with little room for a Western media mogul used to having political clout.

At Beijing University's journalism college, where China's future editors are nurtured, the reach of the Murdoch empire is debated with sophistication by students who conclude that his is not the type of foreign company ‘the Chinese people' require, a damning indictment. A former News executive who worked with Wendi in China says, "she thinks she knows it better than she actually does," and points out that she hasn't lived there for about 20 years. He detects resentment towards her by some in Beijing: "almost a con-tempt as to how she's arrived in some circles, which is not particularly an asset for Rupert". Wendi, he says, has been openly disparaged by Chinese officials in front of her husband, with the non-Mandarin-speaking Rupert not under-standing their harsh comments.

It's a shame that Wendi refused to be interviewed for this article - a hostile News Corporation wouldn't even release her CV or allow emailed questions - as I'm desperate to ask if she pinches herself in disbelief at all that has happened to her in such a short time. The Chinese internet buzzes with Wendi gossip: surely that's not normal for a machinist's daughter from Jiangsu? "She appreciates that she has landed in a very exceptional life situation," says her friend Kathy Freston. "She doesn't pretend that she isn't Mrs Murdoch - but then, she also never abuses it."

*

Wendi Deng grew up in a three-room flat in a sixth-floor walk-up, in one of many blocks built during Mao's reign to house mid-level party functionaries. From her small primary school on Shao Hua Street, known for nurturing ping-pong skills, Wendi went to the Xuzhou No. 1 Middle School, where she was regarded as a student of average to upper ability. The grounds are studded with framed slogans of party heroes and illustrious alumni. Was she inspired by the good deeds inscribed on the Comrade Lei Feng Wall? Or did the aphorisms of Xuzhou's poets and philosophers resonate (All our dreams can come true - if we have the courage to pursue them)? Perhaps she learnt from Xuzhou's history: it's said that if you control the strategically sited city, you control all the territory around you.

Wendi's Xuzhou friends are disappointed that they haven't seen her since 1996, the same year she joined Rupert Murdoch's Star TV as an intern, three years before she married the boss. "I will complain to her once I meet her again," says Li Hong. "You have to stay in touch with your friends." Still, what's a decade for old friends? Li, Wang Chongsheng and Xie Qidong talk about Wendi as though they saw her yesterday. "We've known each other since fourth grade, through middle school, and we lived together, we even shared clothes," says Li. "We biked to school, exercised together and studied at night together," she says. "I never thought that Wendi would achieve such success. I hope Wendi will come to China to invest, and let me hold some position. Isn't Murdoch eager to invest here?"

Li tries to keep up with Wendi's exciting Fifth Avenue life, overlooking Central Park in a US$44-million triplex. She collects every mention of Wendi in the local Xuzhou papers. "Tiandi zhi bie!" she declares, an old saying indicating that the contrast between the Wen Ge she grew up with and the Mrs Murdoch of Manhattan is "the difference between heaven and earth". But the 38-year age gap between her old friend and her old friend's husband doesn't bother Li Hong. From what she knows, she says, "Murdoch loves Wendi and her children. Love has no age limit, as long as it is love."
She wants to know more of her friend's new life, so I relate an anecdote told to me by a former News executive. Wendi's parents, a generation younger than their son-in-law, were staying at the couple's ?at in London, which Wendi has remodelled in a modern Chinese minimalist style. (Her friends say Wendi is fascinated by many cultures and the beautiful things that symbolise them: a Japanese tea ceremony, a delicate orchid, exquisite porcelain.) Rupert came home from the office and was scolded by his mother-in-law for walking into the home with his shoes on: he hadn't removed them at the front door, as is customary for the Chinese middle class. Li Hong laughs - as, apparently, did Rupert at the time. "I know her!" says Li. "There are standards, you know!"

Throughout our day together, Li is feisty, fun and quick with a quip. "Wendi and I were both pretty attractive," she says. "We had a very high head-turning ratio when we cycled past people on the street." I tell her that Wendi's two children were each recently given US$100 million in News Corporation stock by their father. Li's teenage daughter - the only child the state allows her - is dependent on her father's policeman salary of around A$200 a month. I ask Li if Wendi ever gave voice to her ambitions. Did she want to be a doctor? A lawyer? To enter the world of business, or ‘to jump into the sea', as the Chinese saying goes? "At the time we were so pure-minded, we had none of these ideas," Li replies. "She always wanted to go to America and now she has realised that. She loves children; she wanted to have a lot of children."

*

Wendi Deng's volleyball coach, Wang Chongsheng, remembers her as "a calm girl, not very talkative": wenjing, meaning demure without being shy. Her high-school supervisor, Xie Qidong, says that Wendi had to catch up on classes during the year she was under his care. "She lagged behind other students because of playing volleyball," he says. Xie persuaded Wendi to give up sport and devote her energies to the upcoming university-entry exams. "Because she had good health, she could stay very late at night to make up her study," he says. "She has a struggling spirit and made big progress. I also would say she is smart. The cramming was very effective: her exam score reached the first-class university entry standards."

Life was tough in Xuzhou, but it seems that Wendi's parents escaped the worst of Mao's Cultural Revolution. Both were engineers, an acceptable occupation inasmuch as they were not considered intellectuals. Wendi has told intimates that her family was sent to a re-education camp, and that she planted rice and worked in the fields. But her high-school supervisor isn't sure about that. Wendi was a bit young for hard labour; if the Dengs were sent anywhere, Xie Qidong says, it was likely to be a May Seventh Cadre School. The Sinologist Geremie Barmé, of the ANU, describes these as "re-education labour schools but rather less than the Chinese gulag".

While Wendi was in high school, her father moved most of the family to Guangzhou for his job at the People's Machinery Works, but Wendi stayed by herself in Xuzhou for a short while. After she left for the US in 1988, Xie Qidong remembers her father proudly boasting that she had rented a house in Los Angeles for a time, subleasing part of it to make some money. "She also promoted cosmetics, door to door. She drove a lady to work and back home, using the lady's car, which meant she also had a car to use."

Xie is keen to see Wendi back in her old home town. A few years ago, while helping to organise the school's eighty-fifth anniversary, he obtained her email address from someone at CCTV, China's state broadcaster, who knew her. He sent her an invitation to the festivities. No response came.

At the Guangzhou Medical College, feelings are mixed about Wendi. Tutor Zhang Shanli is a little miffed that she doesn't seem to cite her time at the school, or to have completed her course elsewhere. But the college's Western-educated director, Professor Wei Donghai, realises the pulling power of a celebrity. Even though Wendi abandoned her studies in clinical medicine after two years, he'd like to get her back for the college's upcoming fiftieth anniversary. He must be proud of having such an illustrious alumni? "It's very interesting, but I think Miss Deng stayed here for just two to three years ... she was just a normal student." Have they talked to her since she left the college? "We once tried to reach her, but could not find a telephone number." I give him News' office contacts in New York.

They seem surprised to hear that Wendi visits China quite often, on business in Beijing for her husband's comp-any, and are impressed by reports that the Murdochs have acquired a house there. "Does she have children?" Zhang Shanli asks. "Boys or girls?" Two girls, I reveal: five-year-old Grace and three-year-old Chloe. Zhang seems pleased. Professor Wei, who earns a director's salary of about A$1000 a month, seems better informed. He talks about Wendi's daughters each receiving US$100 million in stock from their father. "Amazing, eh?"

*

I meet Du Xiaopeng in a Starbucks in downtown Guang-zhou, around the corner from his scungy office building. The city is heaving with people and traffic; flashing neon lights merge with drizzle to give the Cantonese night a Blade Runner feel. Du, 33, is a rumpled figure: black plastic raincoat, glasses, a hairstyle just a few renminbi away from a pudding-bowl cut. The owner of the Chinese fan site wendideng.com, Du runs many websites; his most popular one is devoted to Tang and Song Dynasty poetry, from which he makes good money.

He explains how he saw an article in the Chinese media about the Murdochs and "was shocked by the age gap between them" and "the lack of information about them", as if somehow the two revelations go together. Enthralled, he decided to do something about it. In August 2005, he registered the domain wendideng.com and started uploading content. Today, it is probably the most comprehensive website, in English or Chinese, devoted to Wendi Deng.

The site, which is reasonably well designed, has a blog and reader forums. One posting, from ‘Emma', reads, "Deng Wendi is my idol! My dream is to get into the political circle. Now I am only 14 but I must succeed!" Another entry, by ‘bbas', states, "if every woman who appeared at a high-level meeting without invitation and ‘spilled' the red wine on the older man's clothes, how would the world be? If that happens ‘Mr Right' would be taking a bath in red wine!" Du says he deletes some of the more offensive entries.

Webmaster Du tells me his rationale for the site was that there was "no concentrated information centred on her" - a powerful woman whom he believes will take a more influential role in the affairs of his country. "I'm not sure Wendi reads it," he says, almost blushing. Most of the site's visitors are from China, though he notices a few coming from the US. He says that no one from News Corporation has approached him to buy the domain name, and he doesn't think he is breaking any laws by registering Wendi's name as a domain. (The mostly undeveloped rupertmurdoch.com has been owned by someone registered in the Cayman Islands since 1997, and has nothing to do with News.)

I ask Du what he would accept for the domain name if a posse of News Corporation lawyers walked into his office to buy it. "I would give it away," he says. "I would give it for free, but maybe in the long term I would benefit from Murdoch." Which sounds vaguely noble and philosophical, except that I later learn he owns another Wendi Deng domain, dengwendi.com, which runs identical content to the first one. It suggests a commercial intent that a plundering media mogul might well understand. Perhaps News Corporation should hire him.

Or maybe not. Du tries to sell advertising on the web-sites, without much success. "I make no money from Wendi," he insists. Du is "awed" by her, and knows many details of her life, most of which he posts online. "For an ordinary Chinese she has been good at creating opportunities for herself," he says. "But I don't love her." He says his wife is bemused by his activities, but she is no fan of Wendi. "She thinks of her as you xinji," he says, a pointed, slightly pejorative Chinese phrase which translates as "having a calculating heart".

"Murdoch would not at all lack beauties [in his life], but I do not regard Wendi as beautiful," Du says. "She has an aim, and she has tried everything to achieve that high level. Many people think she is ambitious and wants to take over Murdoch's business. She should keep low-key. After all, she is Chinese; she represents the Chinese people outside China."

*

On 2 November 2000, little more than 16 months after Rupert Murdoch married Wendi Deng on the deck of the luxury launch he had bought for his retirement with Anna, the Wall Street Journal - America's premier business newspaper, and in May this year the subject of a takeover bid by News Corporation - published an article on its front page headlined "Meet Wendi Deng." The piece covered Wendi Deng's arrival in the US, in February 1988, describing how the well-meaning Cherry family, from Los Angeles, had taken in the teenage Wendi after meeting her in China.

Jake Cherry, at the time 50, was a technician working for a Sino-American joint venture in Guangzhou. The Cherry family's interpreter introduced them to a medical student keen to improve her English. Joyce Cherry, who was then 42, tutored Wendi before returning to Los Angeles with the couple's two children, ten-year-old Eric and five-year-old Kirsten; Jake Cherry stayed on to finish the contract. Soon after Joyce Cherry's return, her husband called to say that Wendi wanted to study in the US. Wendi had abandoned her medical studies in Guangzhou: would Joyce apply to some local colleges on her behalf ? The Cherrys sponsored Wendi's student visa and billeted her in the family home, where the 19-year-old shared a bunk bed with Kirsten. About the time Rupert Murdoch launched Sky Television in Europe, a deal which came close to bankrupting News Corporation, Wendi Deng became - by location if not yet, like, by vocabulary - a ‘Valley Girl'. She even managed to secure a place studying economics at California State University's nearby Northridge campus, CSUN. ("It's not that hard to get in," says Professor Ken Chapman, her tutor there.)

But Joyce Cherry grew "increasingly suspicious about Ms Deng's relationship with her husband", the Wall Street Journal reported. She'd discovered "coquettish" photos of Wendi taken by Jake Cherry in his Guangzhou hotel room. Jake became "infatuated" with Wendi, and she "started making recommendations about his diet and wardrobe". The two were having an affair. Joyce Cherry kicked them out of the family home, and they moved into a nearby apartment together.

Jake Cherry and Wendi Deng married in February 1990, two years after Wendi's arrival in the US. But Jake told Wendi to leave just four months after their wedding, because she was seeing someone else, an American in his twenties named David Wolf. They were divorced in 1992, having been married for two years and seven months - seven months longer, the Wall Street Journal reported, than was required for Wendi to obtain a Green Card. Jake and Wendi had lived together as husband and wife for "four to ?ve months, at the most". "She told me I was a father-concept to her, but it would never be anything else," Jake Cherry was quoted as saying. "I loved that girl."

The article shocked Rupert Murdoch. "He didn't know half of this stuff," says one of the Wall Street Journal reporting team. "She clearly hadn't told him. He never sued us, because it was all true." This was News' own medicine administered to its leader, the man who built an empire in large part through tabloids - London's Sun, Sydney's Daily Telegraph - profiting from delving into the private lives of the famous. News Corporation insiders say that James and Lachlan Murdoch used the Wall Street Journal story to probe their father, partly for traction in the unresolved succession plans and partly to question his judgement.

A Wall Street Journal reporter remembers attending a conference in Los Angeles at which Murdoch was giving a speech, soon after the article was published. Part of the paper's beat in Los Angeles is to cover the movie business, and Murdoch, a major Hollywood player because of Fox Studios, usually made himself available to its journalists. No longer. "I've never seen a man more ashen-faced," says the reporter. "When he saw us, he literally went white and ran away as fast as he could." Maybe he was ill.

*

The Cherry home nestles in a quiet cul-de-sac at the foothills of the San Gabriel Mountains. It is smallish by local standards, a tidy clapboard residence overlooking the smoggy sprawl of the San Fernando Valley. What a contrast for a teenager coming from the Chinese heartland! I imagine Wendi, fresh off the plane, marvelling at the relentlessness of the Americana: the consumer accoutrements of the middle class; the stand-alone bungalows with neat lawns inside white picket fences; the bewildering freeways (driving a car!); the ubiquitous industry that gives the valley its nickname, Pornodelphia; the swimming pools, supermarkets, endless malls, cineplexes, junk-food chains and car yards; the lack of Mao statues.

Joyce Hinton, as she is now known, is not home. But her daughter, Kirsten, 24, is hanging out with a friend, Steve. It was Kirsten's room that Wendi shared back in 1988. "I was young at the time; I was five," she says. "I later found out what type of person she was." Kirsten turns to Steve: "My Dad married her to get her into the country."

I reach Joyce Hinton by phone. She's chatty and thoughtful, and doesn't seem the type to deride people for the sake of it. She's reluctant to meet and discuss once more what she describes as a "very difficult time" for her and her children. "I don't want my 15 minutes of fame to be about Wendi Deng," she explains. "I said my piece to the Wall Street Journal." Hinton confirms the details of the 2000 report, and says that she and Jake Cherry never reconciled. She adds that the interpreter who introduced her to Wendi in 1987, Mr Xuan, later apologised for doing so. "She had a goal and she got there," Hinton says of Wendi. "Surely she's got enough? You'd think she would've accomplished her goal by now."

A New York friend of Wendi's defends her actions. "Can you imagine what it would've been like, how she got there with no knowledge of the culture? It was almost inevitable that she was going to make some mistakes. I don't think she has an evil personality; she just has this incredible ambition coupled with this lack of self-consciousness. She got to California and she wanted to social-climb, to get out of the situation that got her there."

Kathy Freston, who describes herself as a "renowned personal-growth author and spiritual counsellor", first met Wendi at a "media establishment" retreat in 2002. When I ask her about the Cherrys, she says that Wendi "hasn't talked a lot about her time [in Los Angeles], other than the novelty and excitement of moving to America, the newness and challenges of attending an American university."

*

Li Ning is arguably China's most famous athlete. Along with the American runner Carl Lewis, he was the star of the 1984 Los Angeles Olympics, winning three gold medals in gymnastics. Tall and good-looking, Li was a natural symbol of the new, modernising China. He used his celebrity to develop Li Ning sportswear, a sports drink and a nation-wide chain of sports shops - something hitherto unheard of in communist China. He's now one of the country's richest people, and one of its most recognisable: an anything's-possible icon for the post-Mao generations. And he's a friend of Wendi Deng.

Success in the Los Angeles games prompted Li Ning to open the International Gymnastics Academy in Chatsworth, the suburb next to CSUN, where Wendi was studying. Wendi began exercising at the gym and also helped manage the facility for Li, who was busy promoting Beijing's bid for the 2000 Olympics. CSUN tutors remember Wendi handing out ‘Beijing 2000' pins around the campus.

Working with Li and his business partner, Chen Yihong, opened doors for Wendi Deng: both had pull in Beijing, for Chinese politicians, like politicians anywhere, love being seen with famous sportspeople. "Every once in a while she'd be gone for part of a week, interpreting for a group of Chinese businessmen doing deals in New York or somewhere in the US," remembers Professor Daniel Blake of CSUN. "I figured she'd be a mover and shaker; she gave the impression of being well connected in China."

Fleeing the wreckage of two marriages - one of them her own - Wendi Deng was beginning to move in different circles. She did translation work for the sports channel ESPN; she sold cosmetics; she tried to introduce Li Ning's sports drink to California (it didn't catch on). Her CSUN studies continued, with success. Professor Ken Chapman, who has graduation photos of Wendi stored on his computer, remembers her being part of an "extremely bright bunch" of students. "When she arrived, her English wasn't very good, but she learnt rapidly. She did well - pretty much a straight-A student," says Chapman, adding that she was slightly evasive - "there were incidental cover-ups" - about her marital status.

Professor Blake remembers "a trendy dresser, a modern girl". "She wasn't shy outside class, but you had to coax her to respond in class. But you didn't have to tell her how things worked twice." She can't have been too shy: in her senior year, she wowed her class by illustrating an assignment about the economics of overpopulation with that famous image of a nude and heavily pregnant Demi Moore.

Wendi graduated in 1993 and spent the next year working almost full-time at Li Ning's gym - and, presumably, contemplating the future. Though CSUN had an MBA program, Wendi set her sights on Yale ("a better brand name, I guess", notes Professor Blake). She asked Blake to write her a recommendation. "I actually encouraged her to get out of here; she was going places," he says.

When Wendi left California for Yale in 1995, it's not clear whether she had already severed her connection with the Li Ning operation, but in 1996, when she last saw her friends in Xuzhou, she gave out her Li Ning business card, though she said she was studying at Yale. The Ivy League isn't cheap: a former News Corporation executive in China claims that Wendi's then boyfriend, David Wolf, who was learning Mandarin and managed Li Ning's business, helped fund her through the Yale course. Wolf, now a public-relations consultant in Beijing, refused to be interviewed for this article.

*

News Corporation spokesman Andrew Butcher seems anxious. I email a request to interview Wendi, and he responds, "Jesus ... you're scaring the shit out of me with this serious letter. Please don't treat me like a real corporate flak." He turns down the request on her behalf: ... there is no extensive business story to tell about Wendi - her recent interest has been solely focused on MySpace potentially doing something in China. She's not an executive at the company, doesn't fulfil an executive role, and doesn't intend to become an executive. Her primary role is as a great mum to two cute kids.

So, if Wendi isn't working for News Corporation, where should I send questions about her? "I'll look after any and all questions," Butcher replies. "I'm not going to answer questions by email."

A month later, Butcher sends me an unsolicited email. He's done some ringing around and believes I've only been seeking out people who "might have an axe to grind". His missive arrives the same night that I toast Wendi's health in Xuzhou with her old school chums, who are anything but critical of her.

Other friends and associates are much less forthcoming. There's Chen Yihong, the Beijing-based partner of Li Ning, who was close to Wendi when she worked at the Chatswood gym. There's David Wolf, whom she some-times referred to as her husband and whose mother, Valeria, attended Wendi and Rupert's wedding: I'd like to check whether they paid for her Yale tuition. And there's HS Liu, News Corporation's fixer in China, who says he has known Wendi for six years and has been deal-making and house-hunting for the Murdochs in Beijing. He'd love to talk, he tells me, but News recently had him sign a non-disclosure agreement. "I think it lasts a lifetime," he laments.

I seek Butcher's help in freeing these people up. He claims that they "barely know Wendi", and suggests that instead I contact a "long-time friend" such as Professor Jeffrey Garten, who taught her economics at Yale, where Wendi is one of 50-odd trustees of the management school she attended (and the only one whose spouse's occupation is detailed on the Yale website). Garten says he ?rst met her in 1996, which hardly makes him a "long-time friend". "I thought she was very alert, very energetic, and worked very hard," Garten says. "I found her friendly and charming, very curious and interested in learning all she could."

Later, I follow up, seeking any anecdotes he might recall, wondering if Wendi ever expressed any feelings about her homeland. "[I] just didn't know her well enough to provide this kind of detailed info, sorry!" he replies.

*

Yale requires each of its MBA students to work as an intern. Wendi Deng undertook her placement in Hong Kong at Star TV, the Asian satellite broadcaster in which, in 1993, News Corporation had bought a controlling stake. She had sat next to Star's then COO, Bruce Churchill, on a plane, and the two got talking. Knowing how valuable - and how rare - a savvy mainlander could be for a Western-owned business in Hong Kong that was desperate to appear China-friendly, Churchill promptly hired her.

A Star colleague remembers Wendi's first week of work, in May 1996, when she set about introducing herself to the mostly male, mostly expatriate-Australian executive staff. "We were all there to learn, learn, learn - to suck in knowledge - but Wendi would say, ‘I'm going to meet that guy,'" the colleague recalls. "So she would waltz in to someone important's office, unannounced, and exclaim, ‘Hello, I'm Wendi, I'm the intern ... um, who are you?' It was excruciating. It made some people uncomfortable, but she would get away with it; in fact, she perfected it. Over time, I came to understand her approach," the colleague says. "Her English was limited, so what was she going to do with three binders on, say, the ins and outs of Japanese TV foreign-ownership regulations? She was as boot-strapped as they come."

Gary Davey, Star's CEO from 1993 to 1999, remembers Wendi being "a little bit clumsy; she didn't entirely under-stand the traditional niceties of corporate behaviour." It was, he says, "very refreshing. She was fearless, full of charming natural confidence. She didn't have that [Communist] Party arrogance about her that a lot of mainlanders we met did." Davey recalls that some of Star's Hong Kong Chinese staffers - those who had "made a living out of being Chinese" in a Western company - were "a bit uncomfortable with Wendi". Being smart and a mainlander "was a dangerous combination for a lot of them".

At the time, Star TV seemed a controversial asset for News to hold, not just because Hong Kong was returning to China but because Asian autocrats were ever anxious about the ‘cultural pollution' of Western-owned media. For a corporate chameleon like Murdoch, though, such politics was simply passing drama - he dropped the BBC News from Star's roster, and wouldn't publish Hong Kong governor Chris Patten's memoirs, after all - and far less important than Star, which was profitless, becoming a viable business.

By all reports, Wendi Deng livened up the place. One executive remembers her interaction with a colleague, Robert Bland, who ran the advertising department and whose ability to bring in revenue made him an important player. "He could get away with smoking these pungent cigarillos and wearing a ponytail around the office," the executive recalls. Bland soon caught Wendi's attention. The day after she had been introduced to him, he was walking down the corridor past her room. Recalls the executive, "Wendi, this intern, rushes out and grabs Bland's pony-tail, in front of all of us. And she gives it a yank and says in this squeaky voice, ‘Hi Robert! I'm Wendi! Remember me? I'm the intern,' and she just cackles with this kiddie laugh, ‘Ha ha ha ha ha.' Bland was not particularly friendly in the office, and he turns around with this I-can't-believe-someone-did-that-to-me look and sees Wendi standing there, grinning and saying, ‘Hi-ii, it's Wendi, I'm the intern,' and he just melts. That was the day we all got what she was about."

*

Wendi Deng left Star TV after a few months to finish her MBA at Yale. Gary Davey says that the office workers thought it was the last they would see of her, but some months later Wendi showed up again. It was 1997, the year of the Hong Kong handover, and Star was on the rise. The colleagues she'd farewelled the year before had been promoted and, as one executive says, "there was a well-oiled machine operating." Wendi, now earning about US$80,000 a year, was re-assigned to improve Star's sluggish effort in China, seeking outlets for its music channel. "This was perfect for her, because it was just schmoozing; you couldn't actually do much in China," a colleague recalls. "She knew some people, but it wasn't like she was the president's daughter. I don't think she had any existing net-work, but she just started making one. She had no fear."

Wendi moved into a tiny ?at in the unprepossessing area of Hung Hom, near the Star office in Kowloon. Colleagues remember her as being well dressed and having "street-level tastes" outside the office. She'd lunch at a dai pai dong - a roadside hawker stall. On Friday nights, she turned heads partying in Hong Kong's fashionable bar district with friends like Rebecca Li and a Briton, Sue Taylor, who also worked in the media. Another Yale graduate working at Star, Tiffany Soong, was a friend, and she was very close to a wealthy British fund manager, Scobie Ward.

A Star colleague describes her as "a delightful charmer", and very popular with the male expatriate staff, something which inevitably gave rise to rumours. "She loved that she worked for a big, multinational, non-Chinese company in China," recalls one colleague. "She was ambitious, sure, but not in the way that ‘I'm going to write a killer business plan myself and make it work and be recognised for making it work'; she was ambitious in the way that ‘I'm going to meet this person and schmooze this person.'"

But there were times when Wendi did need some paperwork for important meetings. Sometimes she'd write her own and sometimes, one executive recalls, she would schmooze work from her colleagues, playing the role of the unworldly mainlander making her way. "She took advantage of people's naiveté and niceness," the executive says. "And she totally got credit for it. She presents this stuff to the bosses, and her charming self, and then she starts jetting off. If Rupert fell in love with her because of her Excel-spreadsheet business plans, then he should've married me."
Still, the Star executive harbours little malice towards her former colleague. "Was it wilful? Maybe. Does it matter? I've experienced worse. Some of us were a bit pissed off at the time, but we were all a team - at least, that's what we thought. I'm not trashing her ... I was very fond of her. I still am," the executive says, "but Star was no meritocracy. There's a certain amount of guileless guile about her ... she'll set her mind on something, and the way she'll go after it is with a sledgehammer. She's not a genius; she's a sweetheart, she's a party girl, she loves it when everyone is having fun - she likes to facilitate that. That's what she does."
While Rupert Murdoch was the guest of honour of Hong Kong's Chief Executive designate at the official handover ceremony on 30 June 1997, Wendi Deng saw in the transfer at the Hong Kong Cricket Club. A bastion of colonial privilege, the club was an unusual place for a mainlander - and the daughter of a Communist Party member, no less - to witness the act that Beijing believed would rectify an accident of history. And the historical signi?cance of the moment didn't much move her, it seems: "Wendi doesn't have those type of views; she's not at all political," says a friend. "She's the type of person who'll go to a party and she'll come back and tell you who she met and what they said. She's not fixing rockets in her spare time; she's not dumb either ... she's got other gifts."

*

Wendi Deng's Star colleagues began to twig that some-thing was afoot in the first half of 1998. She became furtive and giggly; she took short vacations to Paris and London with someone she described as "my new boyfriend, an older guy", returning with expensive gifts. A News Corporation executive recalls "a weird period when the office started gossiping. Then we started hearing Rupert-isms from Wendi and Wendi-isms from Rupert." Colleagues saw Wendi at Hong Kong's Grand Hyatt Hotel at unusual hours. Then, Rupert and Wendi were spotted holding hands as they strolled around The Peak, a popular lovers' haunt. "She often said she liked older men," a colleague says, "even before she'd met Murdoch."

How did the two meet? One story circulating through Star TV is that she impressed Rupert in the office with a sharp business plan. Another has it that she gatecrashed a Hong Kong dinner he attended, contriving to spill wine on his lap. Rupert told Vanity Fair magazine in October 1999 that when Wendi visited London on Star business in June 1998, he - "a recently separated and lonely man" - took her out for dinner. "I talked her into staying a couple of extra days and that was the start of it," he said.

Gary Davey claims he introduced them, albeit by phone. He was in Delhi; Murdoch was in Japan en route to Shang-hai, and needed an interpreter. "I told her to go to the airport, meet this guy and take him up to Shanghai," Davey recalls. "She said, ‘What's his name?' and I said, ‘Rupert Murdoch,' and in classic Wendi style she said, ‘Oh, OK.'" A long-time Murdoch lieutenant and now a semi-retired private investor living in Coffs Harbour, Davey can't quite remember the timing of that phone call. Though Rupert married Wendi on 25 June 1999, just 17 days after finalising a US$1-billion-plus divorce, he has insisted he was faithful to Anna until the end of the marriage. Murdoch and Wendi "weren't swinging hands immediately," Davey insists. "It took some months for a relationship to develop."

The break-up with Anna stunned all who knew the Murdochs, including the rest of the family. "I thought it was a very strong marriage," says Andrew Neil, a former editor of Murdoch's Sunday Times in London. Gary Davey says that Rupert and Anna "were bullshitting one another" that Rupert would gradually withdraw from the cut-and-thrust of empire building. "He wanted to maintain a halfway-sensible relationship with Anna. I knew he was very unhappy ... There was a polarisation between Anna and Wendi that just transformed him. Rupert was never a ladies' man, but he was invigorated by this young woman who showed an interest in him, was smart, was Chinese, could comfort him ... here was somebody who was energetic, excited, passion-ate, motivated, really smart ... somebody who loves business on a level that almost equals him, and someone who was intimate with a culture that he's most intrigued by."
A Star colleague recalls the time when the relationship went public. Wendi "wanted to talk about all the famous people she'd met. There was a certain amount of boastful-ness to it, but she wasn't really dropping names; she was genuinely starstruck, in a guileless way. The whole thing was very weird." In a similar vein, a News executive remembers that not long after he and his wife met Wendi, she would call them for tips on what to wear to functions she was attending with Rupert. "It was quite sweet, actually. She wasn't showing off; she was genuinely unsure of what was appropriate," he says.

*

Copies of Rupert Murdoch's New York Post are piled high inside the entrance of the Shuang Wen High School, on New York's Lower East Side. The papers are part of a $500,000 donation Wendi made to the school, even though her daughter Grace is schooled elsewhere. Shuang Wen - Mandarin for ‘dual cultures' - sits on Cherry Street, in a tough neighbourhood adjacent to Chinatown. It has one of the state-school system's most impressive academic records, and is popular with uptown New York families who want to give their children a way into China's economic future.
Shuang Wen High School is one of the handful of trusts and charities with which Wendi is associated. She's also a trustee of, and a donor to, the Asia Society, located just a few blocks away from her uptown home. The society is a major networking spot, where the grandees of America's Asian establishment gather to debate policy. News Corporation had its annual meeting there last year. On 30 January this year, the society inaugurated its China Centre with a speech by Henry Kissinger on how he and Richard Nixon began talks with Mao in 1972. It was a big event for New York's Asiaphiles and diplomats: surely Wendi would join Richard Holbrooke, Christopher Hill and the academic Orville Schell in the audience? She didn't.

Perhaps she was with her parents. She moved them to New York soon after marrying Murdoch, installing them in an apartment in Queens, in the middle-class Chinese neighbourhood of Flushing. She showed them the sights and took them shopping on Madison Avenue: a crash course in the West. "It was like Wendi wanted them to catch up," says a friend. "They were decked out in super-fine fabrics, but you could tell that they felt completely uncomfortable. It didn't matter to them, any of that; they would've been just as happy wearing anything." They were "pretty bewildered; they had no English," the friend says, describing them as "very nice people" but "beaten down" after living much of their life under Mao.

In New York, the Murdochs are said to be friendly without being particularly social; they're in the process of crossing from trendy SoHo to the sedate Upper East Side, which is more Rupert's natural habitat. The couple's first formal home, the loft on Prince Street where Rupert started donning the metropolitan black garb that Wendi chose for him, was sold after James, Lachlan and their wives left town. Wendi showed a savvy side when she did a rare interview - with the New York Times' real-estate pages, in October 2005 - ostensibly to help sell the hard-to-shift SoHo loft after Rupert had bought their new apartment on Fifth Avenue. "We are trying to simplify our life," she said in the piece, headlined "Make an Offer" - while lamenting that she'd "have to get a better wardrobe" now that she was moving into the rarefied uptown area.

New York gossips claim Wendi still has some awkward social moments. One friend comments, "I've been at a dinner party where she'll just blindly jump into the conversation, and say something harmless but completely unrelated to the table discussion. Rupert will indulge her, laugh it off, almost in the same way that you'll indulge a child, and Wendi doesn't pick up on that." It's something that the friend presumes is a result of the cultural gap, a "mainland Chinese suddenly flying around on a private jet to meet world leaders. That's got to be weird."

Kathy Freston says she's in contact with Wendi at least once a day as they shuttle between their respective homes in Los Angeles and New York. They share yoga teachers, and Kathy is trying to teach Wendi to meditate. She says that Wendi "talks a mile a minute, and I know sometimes she would like to slow down, but I think there is so much she'd like to get done in a day ... that everything comes tumbling out. I adore her because she is very thoughtful and quirky and brilliant in a completely original and unpretentious way. She has no interest in knowing the right people - she likes who she likes, no matter what station in life they occupy. She doesn't put on false airs."

*

Shortly after he married Wendi Deng in 1999, Rupert Murdoch said in an interview that his new wife's job was "as a home decorator": that she was not "some business genius about to take over News". "She's intelligent, but she's not going to do that," he said. Her friends were incensed. "She didn't marry him to sit at home and be a society wife," says one.

There seems recently to have been a shift in Wendi's role in News Corporation. After the couple visited Beijing late last year, News confirmed reports that it was planning to launch MySpace in China, with Wendi involved in the rollout. Soon after, the Australian CEO of Star TV, Michelle Guthrie, was removed from her post, along with senior executives in Star's Indian operations. That followed the September sell-off of more than half of Star's long-held stake in Phoenix TV - one of News' few meaningful assets in the Chinese media - which reduced its holdings to 17.6%. That was an "ill-advised" move, says Gary Davey, who notes that Phoenix's well-connected chairman, the former People's Liberation Army colonel Liu Changle, "was never comfortable with Wendi always asking questions".

News' offices around the region are now rife with talk that Wendi is starting to exercise her power, starting to build an empire in Asia - something which News denies. "They should absolutely use her," says Jessica Rief Cohen, Merrill Lynch's senior media analyst in New York, when I ask her about Wendi's role in China. "She knows the company, she knows the country and News desperately wants to be in that country in a big way ... they'll do what they have to do to have a presence there."
If she is assuming a grander role for herself at News, can Wendi deliver China to her husband? Gary Davey says that at the very least she'd be an improvement on her predecessors. Over the years, he explains, News has been inundated with fixers, influence-brokers and spruikers promising riches in China but not delivering. "We'd have two or three a day," he remembers, "members of the politburo who'd show up with their hands out. It was just revolting. It's all very well having the connections, the guanxi, and all of that nonsense, but most of the guys who are in that racket wouldn't have a bloody clue about how to run a business." Wendi is different, Davey says, bringing to the role an understanding of the culture and language, and also "really intense business nous, one of the missing pieces of the China puzzle".

That's debatable. In 1999 and 2000, Wendi and her step-son James went on an internet spending spree in China, buying up community websites such as NetEase, SinoBIT, Sinobyte, 21CN and RenRen. All had high profiles in the heady days before the dotcom bust; today, most of them have been wound down by News, with millions of dollars lost. "Her choice of business partners in China has been odd," says a News China colleague.

The internet is one area in which China does not lag behind the West; its emergence as a powerful medium has coincided with the country's economic boom. "Even though MySpace is a big brand in the US, there are plenty of other things in China that have a big head start on MySpace," the News China executive says. "Online gaming is way bigger, so putting Wendi onto MySpace China may be just like putting Wendi in a corner where she can't do much damage." Wendi's former boyfriend David Wolf, who runs a blog on Chinese technology, also seems sceptical. In a posting about the arrival of foreign-owned community web-sites in December last year, Wolf wrote, "MySpace: is China really core to their business? Do they offer something that can't be readily replicated? I cannot shake the feeling that MySpace is showing up now because Rupert has the online bug and Wendi is bored."

*

"There is no one in the company with Rupert's vision or breadth of interest," warns Andrew Neil, a former senior Murdoch employee. "Rupert is the one who had the over-arching vision and the global reach. James knows Britain pretty well now - and Star in Asia, and therefore probably Fox - but does he know anything about motion-picture studios? Does he care about newspapers?" he asks. "Lachlan certainly doesn't care about the British newspapers. [Peter] Chernin, seen as the major executive who would take over if Rupert was not there, couldn't give a stuff about BSkyB, The Times or the papers in Australia. Chase Carey [who runs News' satellite-TV operation in the US] couldn't give a stuff what The Times says. Could Carey find Australia on the map? There's no one."

Neil foresees a break-up of the News empire after Murdoch's death: that his lieutenants will try to secure their corner of the enterprise through management buyouts. "The company will be unbundled, no question; the institutional investors will finally have their say," he says. "My guess is [the break-up] will be messy, because these things usually are, as they divvy up parts of the company. This is a share price that has not performed. Given that the asset value of the company is far greater than its market capitalisation ... there'll be a big push among the shareholders when Rupert goes.

"Wendi has two young kids to look after, but every-body's view is that she is biding her time. She keeps her hand in as to what is going on. He's very close to her. Everybody expects to see her as a rising player. From every-thing I hear about her, underestimating her would be very foolish, particularly in a post-Rupert world. She'll want to be there when the carve-up happens, and she's got two kids who are increasingly being cut in to the post-Rupert pie," says Neil.

"The children of Anna's marriage get on fine with Wendi, but they are wary of the dynastic implications of her and the two children. It worries Anna as well. They're all waiting for the Chinese kids to be inserted into that [dynastic] place, and it causes them apprehension. Rupert's run that company not for the benefit of the shareholders but for dynastic reasons, to keep control of it. His biggest threat to that is a combination of the family falling out [after his death] as they try to divvy up the assets and the institutions saying, ‘News Corp. is over, that's finished, we want to sell,'" Neil explains. "And she, Wendi, will be there for that."

The man behind Muddy Waters

2011-07-10T09:08:00.000-07:00

Jul 7th 2011

The Economist -- CARSON BLOCK isn’t the obvious candidate to show up John Paulson, a hedge-fund star who oversees $37 billion in assets. Mr Block is 35 years old. His previous business ventures include a Shanghai storage company called Love Box Self Storage. He co-authored a book called “Doing Business in China for Dummies”. Muddy Waters Research, his latest firm, has been around for only 12 months.

Most people on Wall Street hadn’t heard of him until last month, when he released a report accusing Sino-Forest, a Chinese forest-plantation operator listed in Canada, of overstating its timber holdings. Spooked investors sold the stock, which plunged by 78% in a matter of days, dealing Mr Paulson, Sino-Forest’s largest shareholder, around $110m in net losses after he dumped all his shares.

In the year since he founded Muddy Waters, Mr Block’s name has become an alarm-bell for investors in Chinese companies. Including Sino-Forest, Muddy Waters has released reports on five firms. In each case the company’s stock sank, and in some cases, like China MediaExpress Holdings, which sells advertising on Chinese buses, the companies were delisted.

Sino-Forest and China MediaExpress deny allegations of fraud; Rino International, a maker of environmental equipment, admitted it had falsified some of its contracts. But Patrick Chovanec of Tsinghua University says that denial and confession are almost incidental: “It’s not that people concluded he’s right about these companies. It’s that they realised they don’t know whether he’s right or not.”

Critics accuse Mr Block of fear-mongering and targeting firms for his own gain. Mr Block, who is earnest and surprisingly bright-eyed for someone who wars with corporate management for a living, insists he is trying to protect investors. He isn’t a “ninja assassin”, he says, beating up companies for the fun of it.

Ninja or not, he works to preserve his mystique. Mr Block divides his time between Hong Kong and America but doesn’t like to disclose his location because he has received death threats. He refuses to share any details about his business model, including whether he has outside investors. “All people need to know is that I have a clear conflict of interest,” he says, referring to the short positions he takes in the firms he researches.

Muddy Waters has no full-time employees except for Mr Block, and hires contractors to help with research. He probably sells subscriptions to his research reports to hedge funds so they can take short positions in the stocks Muddy Waters will target before he releases those reports to the public. But no one admits to knowing which funds are Mr Block’s clients.

Whether his rise to stardom proves short-lived will depend largely on whether his allegations stand up. Sino-Forest, which vehemently denies the accuracy of Mr Block’s claims, has commissioned an independent audit to be released within the next few months. Firms are becoming shrewder at fending off Mr Block’s claims. After he wrote an open letter to Spreadtrum, a semiconductor company, questioning sales figures, management announced a dividend and share buybacks, which gave succour to anxious investors.

Competition is also a threat. More firms are betting against Chinese stocks, so it is becoming more expensive to borrow shares in target companies. Regulators are also trying harder to police Chinese companies listing in America, depriving short-sellers of potential opportunities. On July 11th and 12th American regulators are expected to meet their Chinese counterparts in Beijing to talk about whether they will be allowed to investigate Chinese firms.

Mr Block may have to wade into muddy waters elsewhere. Some think he may look to Hong Kong-listed companies. Mr Block says he may expand his research to other regions, like Latin America. Just don’t expect him to disclose his whereabouts.

Muddy Waters’ Carson Block: ‘I’m Proud of the Impact We’ve Had’

18 Jul 2011 | 08:06 PM ET

CNBC.com -- Carson Block said he had no idea what he was unleashing when he sent out his first report - on a Chinese micro-cap company called Orient Paper.

The founder of Muddy Waters Research emailed it out to 25 friends and around 50 folks in the investment industry – not all of whom he was sure remembered him.

“It was really a test case,” Block told CNBC. “I didn’t have any business plan for Muddy Waters at the time, and no expectation that the market would be interested in this.”

Block issued the report on June 28, 2010, stating that the stock was a “strong sell.” He and fellow researcher Sean Regan were confident it “is a fraud.”

The company had misappropriated “most to all” of the $31.5 million it had raised, overstated revenue by 40 times in 2009 and was “the factory equivalent of a Potemkin village,” the report said.

What happened next shocked Block. The stock, trading above $8 in America just before the report, cratered within 48 hours and is still trading at around $4.

Block said he had bought less than $5,000 of put options against the company, netting him small change.

Winston Yen, the CFO of Orient Paper , told CNBC: "We certainly believe the Muddy Waters report on Orient Paper is totally false, (but) we have to be very careful in picking the right type of thing to do against Muddy Waters."

Block said he was not worried about lawsuits from companies he has targeted, since Muddy Waters was “careful.” He added that he has not been sued by anyone so far.

After Orient Paper, Muddy Waters became renowned as a short seller, spilling the beans on several Chinese stocks listed in North America. It has tapped a vein of skepticism over Chinese small-caps, which often accessed American capital markets through back-door reverse mergers.

Most recently, the company took on Sino-Forest , the Canadian-listed forestry company, which has seen its stock collapse more than 80 percent.

John Paulson’s hedge fund, Paulson & Co., held 34.7 million shares in Sino-Forest but dumped them all at an estimated loss of $720 million.

“We haven’t had the final tap out yet, but I expect that will be coming,” Block said, likening it to the end of a wrestling match.

A restless entrepreneur who has rarely stayed in a job longer than a year, Block, by his own admission has always had a problem with authority. The New York City native grew up in Summit, N.J. where he scraped by, graduating with a 1.4 grade-point average in his senior year.

“I ranked either first or second in my senior year in terms of parties that I hosted,” Block, now 35, recalled. “The police became a regular presence outside my father’s place,” worried about underage drinking.

But high school did give him the germ that’s led to such a high profile. He first got interested in Asia when he spent a month in the summer of 1991 in Toyama, Japan, in a home-stay split between two families.

“We were in a part of Japan where people had never seen Caucasians – it was a far cry in many respects from Tokyo,” he said. The immersion in such a different culture at 15 “made me more flexible when I was somewhat older so that I was able to move to a completely different culture like China.”

Block went on to study business, concentrating in finance, at the University of Southern California, where he also studied Chinese and spent a month in Beijing. He thought its domestic A-share markets might be fit for a business he could develop down the line, by encouraging Chinese savers to shift cash to stocks.

He went on to graduate in law from the Chicago-Kent College of Law, the law school of the Illinois Institute of Technology. He never intended to practice, he said, but was interested in learning how he could act as a better “in-house counsel” to investment firms.

As a young lawyer he moved to Shanghai to work for the law firm Jones Day. He stayed there from the fall of 2005 until the end of 2006, leaving to write a book that he co-authored with Robert Collins, “Doing Business in China for Dummies.”

But the idea of Muddy Waters took root when his father - who runs a research company based in Los Angeles that writes research on small caps - became interested in U.S.-listed Chinese stocks. He asked his son to visit the Orient Paper plant in Baoding City, Hebei, at the start of 2010.

In January 2010, Orient Paper failed its due diligence “with flying colors,” Block said. “The machinery was basically scrap equipment that probably belonged to a state-owned enterprise.”

His father, Bill Block, whose company W.A.B. Capital writes reports in return for shares and warrants, decided not to touch Orient Paper. But his son Carson started wondering if he should write a negative report of his own. It took six months for the first Muddy Waters report to come out because Block was unsure what to do with the information.

He was convinced Orient Paper would fail its next accounting audit. When it passed the audit without issue, he decided to write the report to demonstrate how he could scrutinize Chinese companies, and see if anybody was interested.

They were. Block had hit a nerve targeting a Chinese micro-cap, according to Bob Dodds, the managing director of DRP Capital, which consults companies on mergers and acquisitions in China.

“There was a bubble that was ready to be burst,” Dodds said. “The timing of it clicked,” with too many Chinese companies having gone public through reverse mergers, using the approach to cut fees and skirt listing standards.

But while the time was right, what has surprised investment professionals is that how quickly Muddy Waters caught on and developed a reputation. Many in the Hong Kong hedge fund community said they do not know Block at all. But the markets have been paying attention. “He’s got an incredible amount of attention from investors, and an incredible amount of influence,” Dodds said.

Taking on Sino-Forest may have been the making of the company, Dodds said, because it was a bigger target than many of the other reverse-merger companies, and it had big-name backers like Paulson. At the start of June, Muddy Waters put out a report claiming that the forestry company had overstated its timber holdings. The report caused a vertiginous decline in its shares.

But not all Block’s targets have come off that badly. Muddy Waters published an open letter on its Web site on June 28 to the chairman of chip designer Spreadtrum Communications , questioning the company’s sales trends and turnover in directors.

The shares of Spreadtrum tanked initially, but have rebounded almost as fast, and the company has received the backing of analysts. Quinn Bolton, an analyst at Needham, for instance, reiterated a buy call on the stock, saying Muddy Waters was taking advantage of its success with other targets.

Diana Jovin, Spreadtrum’s vice president of corporate strategy and investor relations, told CNBC, “Our investors have quite a bit of confidence in the company, and the analysts who cover us also believe in the fundamentals of the company.”

Another Chinese company, Hong Kong-listed China Yurun saw its shares lose one-third of their value on a rumor that Muddy Waters would put out a report on the meat producer. The company was already dealing with negative press in the local media, but found it hard to fight research that it hadn’t seen.

“That is the power of the rumor,” Bunny Lee, who has been fielding investor relations calls for the company said. “The Muddy Waters reports are very powerful on Chinese companies.”

Block is also troubled by the incident. All Muddy Waters research is released on its Web site and sent to thousands of subscribers who have now signed up. “I had never even heard of China Yurun,” he said. “Somebody obviously used our name. And that’s something that is very bothersome to me.”

A fake release was also issued on business press release site Briefingwire.com on June 21 that claimed the Securities and Exchange Commission had charged Muddy Waters with fraud. The SEC confirmed it was a hoax, and Muddy Waters said it might resort to litigation if it can tie the press release to a company it targeted.

Block, who now splits his time between the West Coast and Hong Kong, left Shanghai near the end of 2010 for lifestyle reasons and because it would be easier to run Muddy Waters overseas. He said he doesn’t have a fixed team working with him but uses consultants on a project basis.

“I’m quite proud of the impact we’ve had — within a year it’s been a complete sea change,” he said. “My understanding was that within the fraud-committing circles in China, the U.S. markets were a laughing stock. They thought of Americans as dupes willing to snap up any piece of garbage brought out of China. Now it’s the complete opposite.”

He continues to look for fraud cases, and said he was now looking for companies on which he could go long. “If I found a company I really liked, we’d probably make more money on that than all the companies we’ve shorted so far,” he said.

Vinashin Asks Bondholders to Write Off 90% of Debt

2011-06-01T22:16:00.000-07:00

By Bloomberg News - Jun 2, 2011

Vietnam Shipbuilding Industry Group, the state-owned company with more than $4 billion of debt, asked holders of a local-currency bond it defaulted on in April to write off as much as 90 percent of the money owed, according to a bondholder who met company officials last week.

Vinashin told creditors at the meeting in Hanoi it is unable to make any loan payments until 2015 at the earliest, Pham Viet Bac, general director of Ho Chi Minh City-based Sabeco Fund Management, which holds 30 billion dong ($1.5 million) of Vinashin bonds, said by phone yesterday.

“I’m very disappointed,” said Bac. The shipbuilder also declined to provide a copy of its latest audit, he said. Vinashin failed to pay a 9 percent coupon due on April 13 on a 3 trillion dong, 10-year bond issued in 2007.

Vinashin’s financial difficulties have raised concerns about government support for state-owned companies as it tries to speed up a privatization drive, locally referred to as equitization. Prime Minister Nguyen Tan Dung has also asked police to investigate whether there are any signs of corruption at the shipbuilder.

“I want the company to be transparent to its creditors,” Bac said. “We have the right to know.”

Vinashin Chief Executive Officer Truong Van Tuyen declined to comment when reached by phone at his office yesterday. Calls to Chairman Nguyen Ngoc Su weren’t answered.

The shipbuilder also asked foreign lenders for a one-year extension after missing a $60 million principal payment in December for a $600 million loan, Chairman Su said in February. The company hired KPMG to conduct a business review, he said.

The December missed payment showed that government support for banks and state companies isn’t guaranteed, Moody’s Investors Service said in an April 20 report.

Moody’s cut Vietnam’s credit rating one level to B1 on Dec. 15, citing the risk of a balance of payments crisis and Vinashin’s “debt distress.” Standard & Poor’s and Fitch Ratings Ltd. also cut Vietnam’s credit rating last year.

To contact the reporter on this story: K. Oanh Ha in Hanoi at oha3@bloomberg.net

To contact the editor responsible for this story: Edward Johnson at ejohnson28@bloomberg.net

A Hundred Municipalities in US Won’t ‘Make It’

2011-03-31T01:14:00.000-07:00

By Dawn Kopecki

Mar 31, 2011

JPMorgan Chase & Co. (JPM) Chairman and Chief Executive Officer Jamie Dimon said some municipalities will need to renegotiate debt and a hundred may not “make it.”

“I wouldn’t panic about what I’m about to say,” Dimon, 55, said today at a U.S. Chamber of Commerce event in Washington. “You’re going to see some municipalities not make it. I don’t think it’s going to shatter America, I just think it’s a part of the credit cycle.”

Speculation about widespread municipal-bond defaults intensified in December when bank analyst Meredith Whitney predicted that “hundreds of billions” of dollars of municipal bonds may default in 2011 amid pressure to balance budgets.

JPMorgan, the second-biggest U.S. bank by assets, said in February its commercial bank’s municipal-debt holdings are diversified enough to handle a likely increase in defaults. The number of issuers that can’t manage debts may be about a hundred, Dimon said today.

“It’s not going to be thousands,” he said. “It’s going to be maybe a hundred. It’s going to be a small number” out of roughly 14,000 municipalities.

The commercial bank’s $9.7 billion municipal portfolio has about 26 percent of its holdings concentrated in local government bonds, 22 percent in primary and secondary education, 14 percent in state governments and the rest among higher education, utilities, airports and other investments, Todd Maclin, chief executive officer of the unit, said in the presentation last month.

Bond Defaults

Standard & Poor’s said this month that municipal-bond defaults in the first two months of 2011 are down 50 percent from the same period last year. The research followed a report by the consulting firm of Nouriel Roubini, the New York University economist who in 2006 predicted the credit-market collapse, that said about $100 billion of U.S. municipal debt will default in the next five years.

Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said comments that fuel fear in the municipal-bond markets only hurt debt holders and taxpayers.

“Despite the devastation wrought by the captains of our economy, municipalities remain fundamentally strong as credits and pose only the tiniest default risk,” he said.

Golden Goose

Dimon also said excessive U.S. regulation may “hamstring” the financial industry and push business overseas where costs are lower and regulations less stringent. Congress passed hundreds of new rules in the Dodd-Frank Act last year, and bank regulators are working on new capital requirements for U.S. banks.

“We’re starting to add up a whole bunch of things which are negative for America,” he said. New rules on derivatives may hurt U.S. competitiveness, and “if we have higher capital limits than the rest of the world, now you’re just starting to put nails in the coffin.”

He called derivatives laws in Dodd-Frank some of the most “irrational” legislation he’s ever seen. The Durbin amendment, which limits debit-card fees, is “basic price-fixing at its worst,” he said.

“It’s very important that the regulators and our government, the secretary of the U.S. Treasury, the chairman of the Federal Reserve, that they make sure that when we’re done with all of this stuff, American banks can compete with the rest of the world,” Dimon said. “You don’t want to kill one of the golden gooses of healthy capital markets.”

Nuclear Energy Plan Would Use Spent Fuel

2011-03-19T21:43:00.000-07:00

By Peter Baker and Dafna Linzer
Washington Post Staff Writers
Thursday, January 26, 2006

The Washington Post -- The Bush administration is preparing a plan to expand civilian nuclear energy at home and abroad while taking spent fuel from foreign countries and reprocessing it, in a break with decades of U.S. policy, according to U.S. and foreign officials briefed on the initiative.

The United States has adamantly opposed reprocessing spent fuel from civilian reactors since the 1970s because it would produce material that could be used in nuclear weapons. But the Bush program, envisioned as a multi-decade effort dubbed the Global Nuclear Energy Partnership, would invest research money to develop technologies intended to avoid any such risk, the officials said.

The program has been the subject of intense debate within the administration, and although a consensus has been reached about the direction, a senior official said it will not be ready for Bush to announce in his State of the Union address Tuesday. Even the discussion has stirred concerns among nuclear specialists and some members of Congress who consider it an expensive venture that relies on unproven concepts and could increase the danger of proliferation.

The notion of accepting other countries' spent fuel at a time when the United States has had trouble disposing of its own nuclear waste could also prove highly controversial.

But a small initial investment of money has been programmed into the administration's federal budget plan to be sent to Capitol Hill in two weeks. Senate Energy Committee Chairman Pete V. Domenici (R-N.M.) said yesterday that he expects the White House to send accompanying legislation in February.

"I expect a draft bill from the administration next month on spent nuclear fuel," he said. "I will introduce that bill on behalf of the president, hold a hearing on it and mark it up in committee this spring. I hope it will include a nuclear fuel recycling component. If it doesn't, well, I have been a career-long proponent of nuclear fuel recycling and I intend to pursue it aggressively."

Advocates use the word "recycling" to describe an advanced form of reprocessing that, instead of separating plutonium that can be used in bombs from spent fuel, would produce a mixed-oxide fuel too radioactive for terrorists to handle. Such fuel, called MOX, could be used in special reactors that exist in France but not in the United States.

Edwin Lyman, a senior scientist with the Union of Concerned Scientists, a nonprofit think tank that studies environmental and security issues, said U.N. nuclear inspectors would not make a distinction between that material or the kind of separated plutonium the world is worried Iran might get.

"We think they are putting a fig leaf on it by calling it proliferation-resistant and saying that it's not really reprocessing, so concerns about proliferation risks won't be valid," he said. "But if we develop something that we call proliferation-resistant and it really isn't, then other countries are going to claim rights to this technology. If it's really proliferation-resistant, would we let Iran have it?"

The fuel proposal is part of a broader push by the president for domestic and global nuclear energy. With worldwide energy demands on the rise and U.S. reliance on foreign oil increasing, Bush has held out nuclear power as a solution that will not affect global warming. "We ought to have more nuclear power in the United States of America," Bush said in a speech last week in Loudoun County. "It's clean, it's renewable, it's safer than it ever was in the past."

In a modern version of the Atoms for Peace program during President Dwight D. Eisenhower's administration, officials said the administration envisions helping developing countries build small nuclear reactors that would produce about 5 to 10 percent of the energy generated by a typical reactor now on line in the United States. Some in Congress believe a global nuclear energy program is aimed at aiding the U.S. effort to build an alliance with India, which is eager for U.S. civilian nuclear technology.

Two senior U.S. officials traveled last week to several countries, including Japan and Russia, to brief them about the initiative. At one session, according to a source who was present, the administration officials said the United States has finally moved on from the Three Mile Island nuclear incident in 1979 that paralyzed the industry for years.

Bush has been briefed on the plan but has not given his final approval while diplomats consult with other nations, a senior administration official said. Energy Secretary Samuel W. Bodman hinted at the initiative in a November speech at the Carnegie Endowment for International Peace.

"The world will need much more energy in coming decades," he said, citing projections showing global demand increasing as much as 50 percent by 2025. "How do we meet this demand? How do we do it in a way that leaves all the nations of the earth safer and more secure? The search for answers to these questions increasingly points in one direction: nuclear energy."

Rather than just provide nuclear fuel to other countries that want to have their own reactors, Bodman suggested, the United States would also take back the fuel once it has been spent. "In the longer term, we see fuel-cycle states offering cradle-to-grave fuel-cycle services, leasing fuel for power reactors and then taking it back for reprocessing and ultimate disposition."

The main purpose for reprocessing spent fuel is to extract the radioactive plutonium within it and use that to fuel a reactor. But the process is considered dangerous, and many countries gave up civilian reprocessing years ago.

Officials briefed on the Bush plan said $250 million -- less than requested by the Energy Department -- will be included in the fiscal 2007 budget in a down payment on what they expect to be billions of dollars of spending. Among other things, it would pay for a pilot plant, possibly at the department's Savannah River facility in South Carolina, to test chemical reprocessing. If the program goes forward as planned, the domestic nuclear industry stands to reap hundreds of millions of dollars.

U.S. officials said they are interested in developing reactors that would not produce spent fuel that could be accessed by recipient countries. One model is a self-contained reactor that cannot be opened, is never refueled and is removed when it runs out of energy. Another, known as a pebble-bed reactor, has been under development in Germany and South Africa and likewise would not have fuel that could be used for weapons.

Staff writer Justin Blum contributed to this report.

Why Japan will avert a fiscal meltdown

2011-03-17T21:05:00.000-07:00

Thu, Mar 17 2011

By Alan Wheatley

TOKYO (Reuters) - In these dark hours, Japan would do well to heed former White House Chief of Staff Rahm Emanuel's memorable maxim that you never want a serious crisis to go to waste.

As the nation struggles to avert a nuclear catastrophe on the heels of a deadly earthquake and tsunami, it takes a huge leap of faith to foresee any positives emerging from the triple disaster for a stagnant, rapidly aging and heavily indebted economy.

Yet a number of experts say the disaster might -- just might -- shake Japan out of its collective economic and political torpor of the past two decades and provide a new sense of purpose for a nation that has seemingly lost its way.

They also say that widespread fear of a Japanese fiscal death spiral is mostly overblown.

Masaru Hamasaki, a senior strategist at Toyota Asset Management in Tokyo, said the severity of the challenge facing Japan should not be underestimated.

The numbers killed in last Friday's quake centered on Sendai in northeastern Japan will far exceed the 6,400 toll from the 1995 temblor in Kobe.

Many more people have been affected directly and indirectly, for instance by power cuts and the risk of radioactive fallout from the crippled Fukushima Daiichi nuclear power plant. The usually bustling streets of Tokyo were eerily empty this week.
And the economy is even less vigorous than in 1995, smack in the middle of Japan's so-called Lost Decade.

"But out of this crisis affecting a large part of the population, a sense of 'public morality' is already building up," Hamasaki said. "If the country's leaders can harness this spirit in the long term, then I'm sure Japan will move in a positive direction."

This civic duty, an impulse of shared responsibility, is likely to count for more than any spreadsheet in trying to assess the impact on Japan's bond markets of financing the still unknowable bill of rebuilding after the quake, the strongest on record here.

Some pundits fear that adding substantially to a gross debt burden that is already more than twice Japan's national output will be the straw that breaks the bond market's back.

"The debt will rise significantly. Until now, the country could finance its obligations at relatively low rates. If additional debts come on top now, there will be questions about solvency," Peter Bofinger, a member of Germany's "wisemen" council of economic advisers, said in an interview with the German daily Sueddeutsche Zeitung published on Monday.

Economics Minister Kaoru Yosano has acknowledged that, unless it changes its ways, Japan faces a fiscal dead end.

But the Sendai quake is very unlikely to trigger that day of reckoning.

No Foreign Money Needed

On paper, Japan's liabilities will hit 204 percent of GDP this calendar year, larger than 137 percent for Greece and 113 percent for Ireland, according to the Organization for Economic Co-operation and Development (OECD).

But Japan is not about to follow Greece and Ireland into the emergency debt ward. Both countries have needed a bailout arranged by the eurozone and the International Monetary Fund.

For a start, the government owes nearly half of the debt to other arms of the government such as the Japan Post Bank and the Government Pension Investment Fund. The Bank of Japan also owns a tidy chunk of Japanese Government Bonds (JGBs).

Net debt, taking account also of Japan's official foreign reserves, will reach 120 percent of GDP this year, according to the OECD.

That will be the highest among major economies, but the burden is not significantly greater than that shouldered by Belgium and Italy in the 1990s, both of which avoided a sovereign debt crisis.

True, net debt has risen sharply from 80 percent of GDP in 2007, and the government is running a budget deficit of close to 10 percent of GDP even before counting the cost of the quake.

But whereas about 70 percent of Greece's public debt is held by foreigners, domestic investors hold 95.4 percent of Japan's bonds. This gives Tokyo's policymakers a huge advantage.

"They have much more room to maneuver than Greece or Ireland would have in similar circumstances," said Marcus Noland of the Peterson Institute of International Economics in Washington.

"One has to assume Japanese residents are a much less footloose debt-owning class than, say, London hedge funds."

Quite apart from the fact that low-yielding JGBs have proved a good investment in recent deflationary years, Noland expects banks, insurers and pension funds will readily accede if the government asks them to buy extra quake reconstruction bonds. In a country with a high degree of social cohesion, the loyalty of individual investors in Japan's hour of need can also be taken for granted.

"If the government says 'we're going to tighten our belts; cut expenditure in other areas and shift spending to rebuild Sendai; and we're going to issue more bonds at the margin to make that happen', I simply do not believe the Japanese public is going to dump Japanese bonds," Noland said.

Jeremy Lawson, an economist with the Institute of International Finance, a lobby group for global banks in Washington, agreed. The trajectory of Japan's debt is unsustainable, but, in the short term, "domestic residents may display even greater willingness to lend to the government as an act of national solidarity," Lawson said in a report.

A Rich, Aging Society

That's today, though. What about the future?

If Japan's households are avid buyers of bonds, it is because they are sitting on a mountain of savings -- some 1,400 trillion yen ($17,320 billion), compared with approximately 870 trillion yen in outstanding long-term government bonds.

Japanese workers built up that huge nest egg as they toiled successfully to rebuild their country from the ashes of World War Two. But the young workforce that catapulted Japan ahead of West Germany in the 1960s to become the world's second-largest economy is now aging fast. Pensioners are now spending those savings.

Little noticed by the rest of the world, Japan's household savings rate has in fact already plunged to about 3 percent of disposable income from a peak of 18 percent in the early 1980s.

Despite the government's big budget deficit, Japan still enjoys surplus national savings, reflected in a current account surplus, thanks to high corporate savings and a large income stream from its overseas investments. Japan is the world's largest creditor nation, with net external assets of 225.5 trillion yen, according to official figures.

The question preoccupying economists is how long it will take for the savings rate to erode and drive the current account into deficit. At that point, Japan will have to import capital to balance its books. That's when unexpected shocks like the Sendai quake could trigger a financial as well as a humanitarian crisis by undermining the confidence of foreign investors.

"Without policy adjustment, the space for household assets to absorb public debt will continue to shrink over the medium term," said Kiichi Tokuoka, an economist with the International Monetary Fund.

In a January 2010 working paper, he said Japan's gross public debt could exceed households' gross financial assets by 2015 or 2020, depending on the accounting treatment.

"Although these results do not imply any specific turning point for public debt financing, they suggest that if current trends continue, domestic financing could become more difficult toward the mid-2010s, placing a premium on other sources of funding, including from overseas," he wrote.

Be Bold

George Magnus, senior economic adviser to UBS in London, guessed that three years was too short a time for Japan to reach the turning point. But 10 years was too long because the aging of the workforce was inexorable.

"At some point in the medium term, I do think there's a sporting possibility that Japan will start to run trade deficits and have to start selling debt abroad," said Magnus, the author of a study on the economics of aging. "And that probably is when the crunch will come, because people will want to see Japan taking material measures to manage its public debt over the longer term."

Crucially, no respected economist is arguing that Japan should think twice about spending right away whatever is needed to put the economy back on its feet.

One of the lessons from the recession brought on by the collapse of investment bank Lehman Brothers in 2008 is that the increase in the public debt ratio in Japan and other countries was not due to fiscal spending to stimulate the economy. Rather, it was more due to the abrupt slowdown in economic growth.

The government should do the same today, said Sebastian Mallaby, an economist with the Council on Foreign Relations in New York.

"It should be willing to act aggressively to increase the budget deficit in order to have the money to rebuild the damaged areas promptly," he wrote on CFR's website. "Now is not the time for being cautious or conservative. Now is the time for a bold response, and I've got every reason to think that they will do that," he added.

Political Mess

When the time comes to rein in the budget deficit, Japan already knows from years of experience what Greece and Ireland and other countries are just discovering: there is no secret recipe. It's "simply" a question of agreeing on a politically acceptable mix of tax increases and spending cuts.

The IMF and other agencies have zoomed in on Japan's low rate of consumption tax, five percent, as the most promising candidate to raise the revenue needed to help stabilize the government's debt-to-GDP ratio. In its 2010 review of Japan, the Fund projected that by 2015 gross debt would reach 250 percent, and net debt 154 percent, unless there was a shift in policy.

The government could raise some 2.5 trillion yen for each 1 percentage point rise in the consumption tax.

But a hamstrung political process has hobbled policymaking. Prime Minister Naoto Kan is the fifth man to hold the job since 2006, and his popularity ratings have been sinking like a stone, further reducing his chances of getting budget bills through a split parliament. Indeed, just hours before Friday's earthquake, Kan, accused of illegally receiving campaign funds, was rebuffing calls from an emboldened opposition for his resignation.

The tantalizing question now is whether the Sendai tragedy will change not only Japan's economic and fiscal outlook but also its politics.

"Kan needs to show his leadership to craft a big supplementary budget. This is the time to show his leadership by gathering ideas from the ruling and opposition parties very quickly," said Hamasaki, the Toyota Asset Management strategist.

Political Game-Changer?

Pessimists suspect any political truce sealed in a moment of national solidarity will be short-lived once reconstruction is under way and the economy is recouping the output lost due to the disaster.

After all, the bursting of Japan's asset bubble in the early 1990s failed to jolt the political class into enacting the difficult structural reforms the economy needed. Japan's nominal GDP is stuck at the level it was at in 1992.

But Noland with the Peterson Institute for International Economics said that successful crisis management on Kan's part would go a long way toward reassuring voters still unsure whether his Democratic Party of Japan is a credible alternative to the Liberal Democratic Party. The LDP has governed Japan for most of the past 60 years. It lost power to the DPJ in 2009.

"Cementing a real two-party system could create 'more normal' politics and push Japan into becoming a truly modern, functioning democracy in the 21st century," Noland said.

"It would make governance more complicated, but it would bring issues such as the coddling of the agricultural sector, immigration reform and defense policies out into the open in a much more transparent, democratic way," he added.

The alternative is that Sendai turns out to be Japan's "Katrina" moment, Noland said, referring to the U.S. authorities' ineffectual initial response to the hurricane that ravaged New Orleans in 2005.

"If they do a bad job, then Japan's aging and risk-averse electorate could go flocking back to the LDP and essentially re-establish the status quo ante of the last 60 years," he said.

Seen in this light, the implications for Japan's economy and investment outlook are profound.

Like everyone, Jim O'Neill, chairman of Goldman Sachs Asset Management in London, is waiting to see how fast-changing events at the Fukushima plant play out. But he said the crisis could act as a catalyst in much the same way that the second oil price shock of the late 1970s prompted an all-out national effort by Japan to improve energy efficiency.

"My hunch is that this is so big it will galvanize change and force Japan's leaders to do more," he said in an email.

Power shares in broker's “Don’t buy” recommendation

2011-03-14T23:40:00.001-07:00

Monday ,Feb 28,2011, Posted at: 14:38(GMT+7)

Brokerages recommended it was not the time to buy power shares as power suppliers looked set to face a tough year.

Power shares have dropped sharply for two years, plunging by an average of more than 21 percent compared with a 2 percent decrease of the VN-Index.

Leading listed names in the power industry including Pha Lai Thermal Power Joint Stock Company (PPC) and Vinh Son - Song Hinh Hydropower Joint Stock Company (VSH) fell 32 percent and 23 percent respectively.

On the Ho Chi Minh Stock Exchange on Feb 28th, PPC remained unchanged at VND11,700 and VSH edged down less than 1 percent to close at VND 12,200. The benchmark VN-Index fell 1.21 percent to end at 461.37.

Financial experts said the companies were in difficult since their hydropower plants struggled in a long dry season and their loans in dollar became bigger due to the stronger greenback.

They also noticed that those plants could not be in full-capacity output as they were in the maintaining period. The power consumption in 2011, meanwhile, is expected to move up by 17.6 percent.

Vinh Son - Song Hinh Hydropower JSC and Thac Ba Hydopower JSC (TBC) expect to improve their earning results as the retail power price is set to move up next month.

Vinh Son - Song Hinh Hydropower JSC and Thac Ba Hydopower JSC (TBC) expect to improve their earning results as the retail power price is set to move up next month.

Vietnam intends to increase the cost of average household electricity by around 18 percent next month. Prime Minister Nguyen Tan Dung said early this month factories and other major energy consumers must cut power use by at least 1 percent, Vietnam News reported.

The profit growth of state-owned Electricity of Vietnam, known as EVN, is low, at 1 percent to 3 percent a year, on low retail prices, according to a statement on the government’s website.

EVN sells electricity at 30 percent to 40 percent lower than production cost, it said. The company buys electricity from China at 5.3 to 14 US cents per kilowatt-hour

However, analysts said the increasing retail price will help improve sales of power distributors, not producers. The return rate will depend on the price of EVN.

Saigon Securities Incorporation (SSI), the country’s biggest brokerage on the HCMC bourse, said difficulties of listed power producers would be solve as the government removes the monopoly of the electricity industry.

Financial experts from the Hanoi-based brokerage VNDirect said power shares, which are in a state-owned industry, would hardly slump further thanks to their high dividend rates and attractive prices.

“The market cap of power companies are lower than a value of a power plant, which makes power shares attractive investments in mid- and long-term,” said a broker in a HCMC-based securities firm.

By Truong Hai – Translated by Vu Minh

Vietnam's banking system faces turbulent conditions

2011-03-14T23:39:00.001-07:00

March 14, 2011--Rising inflation, if not managed properly, may become the fly in the ointment for Vietnam's banks. Recent inflationary pressures, in conjunction with several years of high loan growth and rising borrowing costs, are threatening to undermine the credit quality of the country's banking industry. Although the banks were shielded from the banking crisis in advanced economies, Standard & Poor's Ratings Services believes that a combination of these three factors might result in a rapid deterioration in asset quality, if not properly managed. As mentioned in our reports on the three Vietnamese banks we rate-- Bank for Foreign Trade of Vietnam (Vietcombank; BB-/Negative/B), Bank for Investment and Development of Vietnam (BIDV; BB-/Negative/B), Vietnam Technological And Commercial Joint Stock Bank (BB-/Negative/B)--our ratings have factored in these and other heightened credit risks that could hurt asset quality.

Growing bank credit has increased the system's risks. We believe Vietnam's government is likely to lower the target for bank credit growth to 20% in 2011. In our opinion, however, the target is still too high, given our estimate of the country's bank credit to GDP of 120% as at Dec. 31, 2010, and the rudimentary nature of credit risk management systems and the country's still-evolving regulatory framework. Bank credit already grew about 28% in 2010, exceeding the government's target of 25%. In addition, Vietnam had several years of high credit growth, especially in 2007 and 2009, including loans to large state-owned borrowers, such as the shipbuilding industry group Vinashin (see "Vinashin's Debt Problems Have Cast Uncertainty Over The Creditworthiness Of Vietnam Banks' Exposure To SOEs," published Dec. 12, 2010, on the Global Credit Portal).

Adding to the system's credit vulnerabilities, inflation in the country rose to above 12% year on year in January 2011 from 7.1% in 2009. The government's loosening monetary policy in the second half of 2010, to support economic growth, and rising global commodity prices were responsible for the soaring inflation. If inflation remains high, rising business costs will hinder borrowers' debt servicing ability. On the other hand, overzealous measures by the government in tackling inflation could have a destabilizing effect and undermine confidence in the banking system, like in 2008 when inflation hit a high of 28%.

Borrowing costs in Vietnam have risen sharply. Vietnamese dong (VND) lending rates have increased to 18% for a 12-month loan, from 12% one year ago. In contrast, U.S. dollar lending rates are notably lower at 6%. The wide differential has prompted many businesses to borrow in dollars. Such borrowers, especially those who generate revenues predominantly in dong, increase their exposure to foreign exchange risks. High inflation in Vietnam in the past few years has also weakened confidence in the dong. As a result, residents seek safer haven in gold and dollars. The central bank devalued the dong by 8.5% in February 2011, which is likely to further fuel inflationary pressure.

These developments highlight the volatile operating environment in Vietnam and the importance of sound credit practices for banks to mitigate associated losses. Standard & Poor's acknowledges the ongoing government effort to improve regulatory and risk management standards that will result in much-needed alignment with international norms. However, in our view, the improvements to date have been incremental and have not kept pace with rapid credit growth.

Poor transparency may also contribute to a false sense of security. In our opinion, a disconnect exists between industry-reported nonperforming loan ratios and the true state of the system's asset quality. A slowdown in credit growth and a seasoning of the loan portfolio could expose the true asset quality. In our opinion, the Vietnamese banking system is not sufficiently resilient to prevent a sharp increase in credit losses in the event of system shocks, e.g., due to cyclical downturn or policy missteps.

We believe that the government will be putting more emphasis on stability (versus growth) in its macroeconomic goals for 2011, including the containment of inflation as a priority. While effective government measures might mitigate the impact from inflation and high borrowing costs, ultimately the banks will have to improve their underwriting and due diligence standards to boost their resilience against external shocks.

Time to get back into Vietnam

2011-02-27T20:04:00.000-08:00

By Cris Sholto Heaton • Feb 24, 2011

MoneyWeek.com — You wouldn't know it from what's been going on in the markets lately, but most Asian economies are in pretty good shape. Yes, inflation is a problem. But that's partly due to the region's rapid recovery from the crisis.

Everything that's been said about debt, deleveraging and the outlook in these countries compared to the troubled West remains true. For most markets, the recent sell-off is about fear not fundamentals.

But there are exceptions. One is a country that's been lauded by many – including me – as one of the best long-term prospects around: Vietnam.

Vietnam had a dreadful 2010, hot on the heels of a pretty shabby 2009. So what went wrong? And is now a good time to get back in?

The Vietnamese government needs to get a grip

I backed Vietnam as a good recovery play after the global crisis. And I've tipped it on several occasions since.

So what's the problem? While the rest of Asia has emerged from the crisis in a way that gives investors confidence, Vietnam certainly hasn't.

The country has struggled with three main macroeconomic issues.

First, there's persistently high inflation (12% year-on-year in January).

Second, it has continued to run a yawning trade deficit (around 12% in 2010).

And third, the budget deficit has ballooned to around 8% of GDP in both of the last two years.

Vietnam is not the only country in Asia with one or even two of these conditions. But what bothers investors is this: it's hard to say whether the authorities will get a grip on the situation, or whether Vietnam is instead heading for the traditional emerging market crisis.

For one, there's the central bank. Faith in its judgement and competence has been shaken. When it tried to tighten up on lending in early 2010, it went too far. Loan growth slowed right down, and monetary conditions had to be relaxed. But now it has been far too slow to raise rates to contain inflation. And overly-rapid credit growth means investors are worried that banks will be left sitting on hefty bad debts when the economy slows again.

Similarly, exchange rate policy has been a mess. Vietnam's large trade deficit has left it with foreign exchange reserves of around $10bn-$12bn according to latest reports. That's enough to guarantee only around two months' worth of imports.

The currency – the dong – has been devalued on several occasions in recent years. As you might expect, this combination of high inflation and steady devaluations has encouraged Vietnamese people to switch their earnings into gold or US dollars. And that only pushes the dong down further.

To sum it up, the government has been too willing to tolerate the economy overheating, with all the problems that brings. Why? Because we've just had the five-yearly Communist Party congress. Amid the infighting that surrounded this, senior politicians wanted to be able to point to a solid growth performance – regardless of the consequences.

The $4.4bn cost of copying Korea

As if this wasn't enough, the country's reputation took another hammering late last year with the collapse of state-owned conglomerate Vinashin. This firm was one of the flagships of the government's industrial policy, which has involved building a number of large industrial groups loosely modelled on Korea's giant chaebol such as Samsung and Hyundai.

The fact that China had already tried and rejected this approach should perhaps have warned them off. But it didn't. Thus Vinashin, a shipbuilder, had expanded rapidly into businesses from motorbikes to spas. In doing so, it incurred $4.4bn in debt (around 4% of GDP).

A combination of its incompetence in many new ventures and a downturn in its core business of building ships due to the global crisis brought it to the brink of bankruptcy. Several executives have now been arrested on charges of mismanagement and fraud.

Foreign bond investors had assumed that Vinashin's debt carried an implicit government guarantee. But they may have miscalculated. While the business is being restructured, it's been granted tax relief and soft loans to keep it running. But it missed a debt repayment in December. This has obviously raised concerns about the potential defaults at similar state-owned enterprises (SOEs) such as miner Vinacomin.

And loans to SOEs are said to account for around 40% of Vietnam's banks' assets – which raises worries over possible bad debts there. Small wonder that ratings agencies Moody's, Standard & Poor's and Fitch all downgraded Vietnam last year.

Tougher decisions are being made

Sounds pretty grim. And I can't blame investors for avoiding it.

But Vietnam could be about to turn the corner.

With the congress out of the way, there's a chance that policymaking will become more consistent and pragmatic. The three top officials for the next five years have been chosen.

Nguyen Tan Dung will retain his job as prime minister. Truong Tan Sang will take over as president. And Nguyen Phu Trong will become party general secretary.

I'm no expert on Vietnamese politics. But I gather that both Dung and Sang are considered market-minded reformists (despite mistakes such as Dung being a major supporter of groups such as Vinashin). And it seems there's little love lost between the prime minister and the other two, which may ensure that they hold each other to account. This is something that seems to be a growing trend in Vietnamese politics in any case. The normally compliant national assembly gave Dung quite a hard time over Vinashin – in fact, it wasn't a sure thing that he'd keep his job.

And there are already some concrete signs that better decisions are being made. The official dong exchange rate was devalued by 9% – much more than expected – earlier this month. That brings it much closer to black market rates. Since then, the central bank has hiked rates more aggressively than usual, suggesting it's getting more serious about cooling the economy. On the fiscal front, a government statement this week said that it aims to bring the budget deficit down to less than 5% this year.

And top policymakers seem to realise that they need to reform the state-owned enterprises. Plans to float a couple of the better-run ones – Vietnam Airlines and fuel distributor Petrolimex – on the stock exchange are underway, in an encouraging resurrection of a long-stalled privatisation programme.

Vietnam still has plenty of problems. Beyond the immediate macroeconomic issues, bureaucracy and corruption are major problems. And reforming SOEs will be easier said than done due to their political influence.

But the country also has many strengths, as I've discussed here before. Good demographics, abundant natural resources, substantial foreign direct investment from Asia and elsewhere, and an entrepreneurial culture.

And the current situation perhaps has some parallels to what China went through in the late 1990s and early 2000s, when it restructured many of its SOEs. China emerged stronger from that. (Although bondholders in Vietnamese SOEs today might want to note that China did not stand behind the debt of SOEs such as Guangdong International Trust and Investment Corporation (GITIC) with heavy foreign investment.)

Given my track record on Vietnam so far, it probably doesn't mean much if I think this is the turning point. But others seem to think so.

The discount to net asset value on the Vinacapital Vietnam Opportunity Fund (LN:VOF), an Aim-listed investment trust that's one of the most popular ways to invest in this market, has narrowed from around 35% earlier this year to around 19%.

There is still a risk that Vietnam descends into crisis, perhaps ultimately requiring an international bail-out (which could, in the long run, be a good thing). But I think this is looking less likely. My serial over-optimism so far means that I'm holding back on saying that Vietnam is a good buy at this point – but I am watching it closely.

When Irish Eyes Are Crying

2011-02-27T19:48:00.000-08:00

First Iceland. Then Greece. Now Ireland, which headed for bankruptcy with its own mysterious logic. In 2000, suddenly among the richest people in Europe, the Irish decided to buy their country—from one another. After which their banks and government really screwed them. So where’s the rage?

BY MICHAEL LEWIS • MARCH 2011

When I flew to Dublin in early November, the Irish government was busy helping the Irish people come to terms with their loss. It had been two years since a handful of Irish politicians and bankers decided to guarantee all the debts of the country’s biggest banks, but the people were only now getting their minds around what that meant for them. The numbers were breathtaking. A single bank, Anglo Irish, which, two years before, the Irish government had claimed was merely suffering from a “liquidity problem,” faced losses of up to 34 billion euros. To get some sense of how “34 billion euros” sounds to Irish ears, an American thinking in dollars needs to multiply it by roughly one hundred: $3.4 trillion. And that was for a single bank. As the sum total of loans made by Anglo Irish, most of it to Irish property developers, was only 72 billion euros, the bank had lost nearly half of every dollar it invested.

The two other big Irish banks, Bank of Ireland and, especially, Allied Irish Banks (A.I.B.), remained Ireland’s dirty little secrets. Both older than Ireland itself (the Bank of Ireland was founded back in 1783; A.I.B. is made up of three banks founded in the 19th century), both were now also obviously bust. The Irish government owned big chunks of the two ancient banks but revealed less about them. As they had lent vast sums not only to Irish property developers but also to Irish homebuyers, their losses were also obviously vast—and similar in spirit to the losses at the upstart Anglo Irish.

Even in an era when capitalists went out of their way to destroy capitalism, the Irish bankers set some kind of record for destruction. Theo Phanos, a London hedge-fund manager with interests in Ireland, says that “Anglo Irish was probably the world’s worst bank. Even worse than the Icelandic banks.”

Ireland’s financial disaster shared some things with Iceland’s. It was created by the sort of men who ignore their wives’ suggestions that maybe they should stop and ask for directions, for instance. But while Icelandic males used foreign money to conquer foreign places—trophy companies in Britain, chunks of Scandinavia—the Irish male used foreign money to conquer Ireland. Left alone in a dark room with a pile of money, the Irish decided what they really wanted to do with it was to buy Ireland. From one another. An Irish economist named Morgan Kelly, whose estimates of Irish bank losses have been the most prescient, made a back-of-the-envelope calculation that puts the losses of all Irish banks at roughly 106 billion euros. (Think $10 trillion.) At the rate money currently flows into the Irish treasury, Irish bank losses alone would absorb every penny of Irish taxes for at least the next three years.

In recognition of the spectacular losses, the entire Irish economy has almost dutifully collapsed. When you fly into Dublin you are traveling, for the first time in 15 years, against the traffic. The Irish are once again leaving Ireland, along with hordes of migrant workers. In late 2006, the unemployment rate stood at a bit more than 4 percent; now it’s 14 percent and climbing toward rates not experienced since the mid-1980s. Just a few years ago, Ireland was able to borrow money more cheaply than Germany; now, if it can borrow at all, it will be charged interest rates nearly 6 percent higher than Germany, another echo of a distant past. The Irish budget deficit—which three years ago was a surplus—is now 32 percent of its G.D.P., the highest by far in the history of the Eurozone. One credit-analysis firm has judged Ireland the third-most-likely country to default. Not quite as risky for the global investor as Venezuela, but riskier than Iraq. Distinctly Third World, in any case.

Yet when I arrived, in early November 2010, Irish politics had a frozen-in-time quality to it. In Iceland, the business-friendly conservative party had been quickly tossed out of power, and the women booted the alpha males out of the banks and government. (Iceland’s new prime minister is a lesbian.) In Greece the business-friendly conservative party was also given the heave-ho, and the new government is attempting to create a sense of collective purpose, or at any rate persuade the citizens to quit cheating on their taxes. (The new Greek prime minister is not merely upstanding, but barely Greek.) Ireland was the first European country to watch its entire banking system fail, and yet its business-friendly conservative party, Fianna Fáil (pronounced “Feena Foil”), would remain in office into 2011. There’s been no Tea Party movement, no Glenn Beck, no serious protests of any kind. The most obvious change in the country’s politics has been the role played by foreigners. The Irish government and Irish banks are crawling with American investment bankers and Australian management consultants and faceless Euro-officials, referred to inside the Department of Finance simply as “the Germans.” Walk the streets at night and, through restaurant windows, you see important-looking men in suits, dining alone, studying important-looking papers. In some new and strange way Dublin is now an occupied city: Hanoi, circa 1950. “The problem with Ireland is that you’re not allowed to work with Irish people anymore,” I was told by an Irish property developer, who was finding it difficult to escape the hundreds of millions of euros in debt he owed.

Ireland’s regress is especially unsettling because of the questions it raises about Ireland’s former progress: even now no one is quite sure why the Irish suddenly did so well for themselves in the first place. Between 1845 and 1852, during the Great Potato Famine, the country experienced the greatest loss of population in world history—in a nation of eight million, a million and a half people left. Another million starved to death or died from the effects of hunger. Inside of a decade the nation went from being among the most densely populated in Europe to the least. The founding of the Irish state, in 1922, might have offered some economic hope—they could now have their own central bank, their own economic policies—but right up until the end of the 1980s the Irish failed to do what economists expected them to: catch up with their neighbors’ standard of living. As recently as the 1980s one million Irish people—a third of the population—lived below the poverty line.

What has occurred in Ireland since then is without precedent in economic history. By the start of the new millennium, the Irish poverty rate was under 6 percent and by 2006 Ireland was one of the richest countries in the world. How did that happen? A bright young Irishman who got himself hired by Bear Stearns in the late 1990s and went off to New York or London for five years returned feeling poor. For the better part of a decade there has been quicker money to be made in Irish real estate than in investment banking. How did that happen?

For the first time in history, people and money longed to get into Ireland rather than out of it. The most dramatic case in point are the Poles. The Polish government keeps no comprehensive statistics on the movement of its workforce, but its foreign ministry guesstimates that, since the country’s admission to the European Union, more than a million Poles have left Poland to work elsewhere. At the peak, in 2006, as many as a quarter-million of them were in Ireland. For the United States to achieve a proportionally distortive demographic effect, it would need to hand green cards to 17 million Mexicans.

How did any of this happen? There are many theories: the elimination of trade barriers, the decision to grant free public higher education, the persistent lowering of the corporate tax rate, beginning in the 1980s, which turned Ireland into a tax haven for foreign corporations. Maybe the most intriguing was offered by a pair of demographers at Harvard, David E. Bloom and David Canning, in a 2003 paper called “Contraception and the Celtic Tiger.” Bloom and Canning argued that a major cause of the Irish boom was a dramatic increase in the ratio of working-age to non-working-age Irish brought about by a crash in the Irish birthrate. This had been driven mainly by Ireland’s decision, in 1979, to legalize birth control. That is, a nation’s fidelity to the Vatican’s edicts was inversely proportional to its ability to climb out of poverty: out of the slow death of the Catholic Church arose an economic miracle.

The Harvard demographers admitted their theory explained only part of what had happened. At the bottom of the success of the Irish there remains, even now, some mystery. “It appeared like a miraculous beast materializing in a forest clearing,” writes the pre-eminent Irish historian R. F. Foster, “and economists are still not entirely sure why.” Not knowing why they were so suddenly so successful, the Irish can perhaps be forgiven for not knowing exactly how successful they were meant to be. They had gone from being abnormally poor to being abnormally rich, without pausing to experience normality. When, in the early 2000s, the financial markets began to offer virtually unlimited credit to all comers—when nations were let into the dark room with the pile of money and asked what they would like to do with it—the Irish were already in a peculiarly vulnerable state of mind. They’d spent the better part of a decade under something very like a magic spell.

A few months after the spell was broken, the short-term parking-lot attendants at Dublin Airport noticed that their daily take had fallen. The lot appeared full; they couldn’t understand it. Then they noticed the cars never changed. They phoned the Dublin police, who in turn traced the cars to Polish construction workers, who had bought them with money borrowed from Irish banks. The migrant workers had ditched the cars and gone home. Rumor has it that a few months later the Bank of Ireland sent three collectors to Poland to see what they could get back, but they had no luck. The Poles were untraceable: but for their cars in the short-term parking lot, they might never have existed.

True Love’s First Kiss

Morgan Kelly is a professor of economics at University College Dublin, but he did not, until recently, view it as his business to think much about the economy under his nose. He had written a handful of highly regarded academic papers on topics (such as “The Economic Impact of the Little Ice Age”) considered abstruse even by academic economists. “I only stumbled on this catastrophe by accident,” he says. “I had never been interested in the Irish economy. The Irish economy is tiny and boring.” Kelly saw house prices rising madly and heard young men in Irish finance to whom he had recently taught economics try to explain why the boom didn’t trouble them. And they troubled him. “Around the middle of 2006 all these former students of ours working for the banks started to appear on TV!” he says. “They were now all bank economists, and they were nice guys and all that. And they were all saying the same thing: ‘We’re going to have a soft landing.’ ”

The statement struck him as absurd: real-estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long-term investment real estate has become and flee the market, and the market will crash. It was in the nature of real-estate booms to end with crashes—just as it was perhaps in Morgan Kelly’s nature to assume that, if his former students were cast on Irish TV as financial experts, something was amiss. “I just started Googling things,” he says.

Googling things, Kelly learned that more than a fifth of the Irish workforce was employed building houses. The Irish construction industry had swollen to become nearly a quarter of the country’s G.D.P.—compared with less than 10 percent in a normal economy—and Ireland was building half as many new houses a year as the United Kingdom, which had almost 15 times as many people to house. He learned that since 1994 the average price for a Dublin home had risen more than 500 percent. In parts of the city, rents had fallen to less than 1 percent of the purchase price—that is, you could rent a million-dollar home for less than $833 a month. The investment returns on Irish land were ridiculously low: it made no sense for capital to flow into Ireland to develop more of it. Irish home prices implied an economic growth rate that would leave Ireland, in 25 years, three times as rich as the United States. (“A price/earning ratio above Google’s,” as Kelly put it.) Where would this growth come from? Since 2000, Irish exports had stalled, and the economy had been consumed with building houses and offices and hotels. “Competitiveness didn’t matter,” says Kelly. “From now on we were going to get rich building houses for each other.”

The endless flow of cheap foreign money had teased a new trait out of a nation. “We are sort of a hard, pessimistic people,” says Kelly. “We don’t look on the bright side.” Yet, since the year 2000, a lot of people had behaved as if each day would be sunnier than the last. The Irish had discovered optimism.

Their real-estate boom had the flavor of a family lie: it was sustainable so long as it went unquestioned, and it went unquestioned so long as it appeared sustainable. After all, once the value of Irish real estate came untethered from rents there was no value for it that couldn’t be justified. The 35 million euros Irish entrepreneur Denis O’Brien paid for an impressive manor house on Dublin’s Shrewsbury Road sounded like a lot until a trust controlled by the real-estate developer Sean Dunne’s wife reportedly paid 58 million euros for a 4,000-square-foot fixer-upper just down the street. But the minute you compared the rise in prices to real-estate booms elsewhere and at other times, you re-anchored the conversation; you biffed the narrative. The comparisons that sprung to Morgan Kelly’s mind were with the housing bubbles in the Netherlands in the 1970s and Finland in the 1980s, but it almost didn’t matter which examples he picked: the mere idea that Ireland was not sui generis was the panic-making thought. “There is an iron law of house prices,” he wrote. “The more house prices rise relative to income and rents, the more they subsequently fall.”

The problem for Kelly, once he had these thoughts, was what to do with them. “This isn’t my day job,” he says. “I was working on medieval-population theory.”

By the time I got to him, Kelly had angered and alienated the entire Irish business and political establishments, but he himself is neither angry nor alienated, nor even especially public. He’s not the pundit type. He works in an office built when Irish higher education was conducted on linoleum floors, beneath fluorescent lights, surrounded by metal bookshelves, and generally felt more like a manufacturing enterprise than a prep school for real estate and finance—and he likes it. He’s puckish, unrehearsed, and apparently—though in Ireland one wants to be careful about using this word—sane. Though not exactly self-effacing, he is clearly more comfortable talking and thinking about subjects other than himself. He spent years in graduate school, collecting a doctorate from Yale, and yet somehow retained an almost child-like curiosity. “I was in this position—sort of being a passenger on this ship,” he says. “And you see a big iceberg. And so you go and ask the captain: Is that an iceberg?”

His warning to his ship’s captain took the form of his first-ever newspaper article. Its bottom line: “It is not implausible that [Irish real-estate] prices could fall—relative to income—by 40 to 50 per cent.” (They did.) He sent his piece to the small-circulation Irish Times. “It was a whim,” he says. “I’m not even sure that I believed what I was saying at the time. My position has always been ‘You can’t predict the future.’ ” As it happened, Kelly had predicted the future with uncanny accuracy, but to believe what he was saying you had to accept that Ireland was not some weird exception in human financial history. “It had no impact,” Kelly says of his piece. “The response was general amusement. It was What will these crazy eggheads come up with next? sort of stuff.”

What the crazy egghead came up with next was the obvious link between Irish real-estate prices and Irish banks. After all, the vast majority of the construction was being funded by Irish banks. If the real-estate market collapsed, they would be on the hook for the losses. “I eventually figured out what was going on,” says Kelly. “The average value and number of new mortgages peaked in summer 2006. But lending standards were clearly falling after this.” The banks continued to make worse loans, but people borrowing the money to buy houses were growing wary. “What was happening,” says Kelly, “is that a lot of people were getting cold feet.” The consequences for Irish banks—and the economy—of the inevitable shift in market sentiment would be catastrophic. The banks’ losses would lead them to slash their lending to actually useful businesses. Irish citizens in hock to their banks would cease to spend. And, perhaps worst of all, new construction, on which the entire economy was now premised, would cease.

Kelly wrote his second newspaper article, more or less predicting the collapse of the Irish banks. He pointed out that in the last decade they and the economy had fundamentally changed. In 1997 the Irish banks were funded entirely by Irish deposits. By 2005 they were getting most of their money from abroad. The small German savers who ultimately supplied the Irish banks with deposits to re-lend in Ireland could take their money back with the click of a computer mouse. Since 2000, lending to construction and real estate had risen from 8 percent of Irish bank lending (the European norm) to 28 percent. One hundred billion euros—or basically the sum total of all Irish public bank deposits—had been handed over to Irish property developers and speculators. By 2007, Irish banks were lending 40 percent more to property developers than they had to the entire Irish population seven years earlier. “You probably think that the fact that Irish banks have given speculators €100 billion to gamble with, safe in the knowledge that taxpayers will cover most losses, is a cause of concern to the Irish Central Bank,” Kelly wrote, “but you would be quite wrong.”

This time Kelly sent his piece to a newspaper with a far bigger circulation, the Irish Independent. The Independent’s editor wrote back to say he found the article offensive and wouldn’t publish it. Kelly next turned to The Sunday Business Post, but the editor there just sat on the piece. The journalists were following the bankers’ lead and conflating a positive outlook on real-estate prices with a love of country and a commitment to Team Ireland. (“They’d all use this same phrase, ‘You’re either for us or against us,’ ” says a prominent bank analyst in Dublin.) Kelly finally went back to The Irish Times, which ran his article in September 2007.

A brief and, to Kelly’s way of thinking, pointless controversy ensued. The public-relations guy at University College Dublin called the head of the department of economics and asked him to find someone to write a learned attack on Kelly’s piece. (The department head refused.) A senior executive at Anglo Irish Bank, Matt Moran, called to holler at Kelly. “He went on about how ‘the real-estate developers who are borrowing from us are so incredibly rich they are only borrowing from us as a favor.’ I wanted to argue, but we ended up having lunch. This is Ireland, after all.” Kelly also received a flurry of worried-sounding messages from financial people in London, but of these he was dismissive: “I get the impression there’s this pool of analysts in the financial markets who spend all day sending scary e-mails to each other.” He never found out how much influence his little newspaper piece exerted on the minds of people who mattered.

It wasn’t until almost exactly one year later, on September 29, 2008, that Morgan Kelly became the startled object of popular interest. The stocks of the three main Irish banks, Anglo Irish, A.I.B., and Bank of Ireland, had fallen by between a fifth and a half in a single trading session, and a run on Irish bank deposits had started. The Irish government was about to guarantee all the obligations of the six biggest Irish banks. The most plausible explanation for all of this was Morgan Kelly’s narrative: the Irish economy had become a giant Ponzi scheme and the country was effectively bankrupt. But it was so starkly at odds with the story peddled by Irish government officials and senior Irish bankers—that the banks merely had a “liquidity” problem and that Anglo Irish was “fundamentally sound”—that the two could not be reconciled. The government had a report thrown together by Merrill Lynch, which declared that “all of the Irish banks are profitable and well capitalised.” The difference between this official line and Kelly’s was too vast to be split. You believed either one or the other, and until September 2008, who was going to believe this guy holed up in his office wasting his life writing about the impact of the Little Ice Age on the English population? “I went on TV,” says Kelly. “I’ll never do it again.”

Kelly’s colleagues in the University College economics department watched his transformation from serious academic to amusing crackpot to disturbingly prescient guru with interest. One was Colm McCarthy, who, in the Irish recession of the late 1980s, had played a high-profile role in slashing government spending, and so had experienced the intersection of finance and public opinion. In McCarthy’s view, the dominant narrative inside the head of the average Irish citizen—and his receptiveness to the story Kelly was telling—changed at roughly 10 o’clock in the evening on October 2, 2008. On that night, Ireland’s financial regulator, a lifelong Central Bank bureaucrat in his 60s named Patrick Neary, came live on national television to be interviewed. The interviewer sounded as if he had just finished reading the collected works of Morgan Kelly. Neary, for his part, looked as if he had been dragged from a hole into which he badly wanted to return. He wore an insecure little mustache, stammered rote answers to questions he had not been asked, and ignored the ones he had been asked.

A banking system is an act of faith: it survives only for as long as people believe it will. Two weeks earlier the collapse of Lehman Brothers had cast doubt on banks everywhere. Ireland’s banks had not been managed to withstand doubt; they had been managed to exploit blind faith. Now the Irish people finally caught a glimpse of the guy meant to be safeguarding them: the crazy uncle had been sprung from the family cellar. Here he was, on their televisions, insisting that the Irish banks were “resilient” and “more than adequately capitalized” … when everyone in Ireland could see, in the vacant skyscrapers and empty housing developments around them, evidence of bank loans that were not merely bad but insane. “What happened was that everyone in Ireland had the idea that somewhere in Ireland there was a little wise old man who was in charge of the money, and this was the first time they’d ever seen this little man,” says McCarthy. “And then they saw him and said, Who the fuck was that??? Is that the fucking guy who is in charge of the money??? That’s when everyone panicked.”

The Drinks Cabinet

On the morning in early November when the Irish government planned to unveil a brutal new budget, I take my seat in the visitors’ gallery of the Irish Parliament. Beside me sits an aide to Joan Burton, who, as the Labour Party’s financial spokesperson, was at the time a fair bet to become the next minister of finance, the unnatural heir to an unholy mess. Down on the floor the seats are mostly empty, but a handful of politicians, Burton included, discuss what they have been discussing without intermission for the past two years: the nation’s financial crisis.

The first thing you notice when you watch the Irish Parliament at work is that the politicians say everything twice, once in English and once in Gaelic. As there is no one in Ireland who does not speak English and a vast majority who do not speak Gaelic, this comes across as a forced gesture that wastes a great deal of time. I ask several Irish politicians if they speak Gaelic, and all offer the same uneasy look and hedgy reply: “Enough to get by.” The politicians in Ireland speak Gaelic the way the Real Housewives of Orange County speak French. To ask “Why bother to speak it at all?” is of course to miss the point. Everywhere you turn you see both emulation of the English and a desire, sometimes desperate, for distinction. The Irish insistence on their Irishness—their conceit that they’re more devoted to their homeland than the typical citizen of the world is—has an element of bluster about it, from top to bottom. At the top are the many very rich Irish people who emit noisy patriotic sounds but arrange officially to live elsewhere so they don’t have to pay tax in Ireland; at the bottom, the waves of emigration that define Irish history. The Irish people and their country are like lovers whose passion is heightened by their suspicion that they will probably wind up leaving each other. Their loud patriotism is a cargo ship for their doubt.

On this day, in addition to awaiting word on the budget, the Dáil (pronounced “Doyle”), as the Irish call their House of Commons, has before it a vote on whether to hold elections to fill its four empty seats. The ruling party, Fianna Fáil, holds a slim majority of two seats and, because they are universally believed to have created a financial catastrophe, an approval rating of 15 percent. If the elections were held today, they’d be tossed from power—in itself a radical idea, as they have more or less ruled Ireland since its founding as an independent state. Yet they have successfully resisted the call to fill the empty seats.

A bell rings for a vote, and Irish politicians stream in. A few minutes before the vote, the doors to their chamber will be closed and guarded. A politician who is late is a politician who cannot vote. A glass barrier separates the visitors’ gallery and the floor: I ask my tour guide about it. “It’s not to stop people from throwing things at their government,” she says, then goes on to explain. Some years ago an Irish politician came late, after the doors had been locked. He ran up to the visitors’ gallery, jumped down from it into the press gallery, 10 feet below, and from there rappelled down the wall to the floor. They allowed the vote, but put up the glass barrier. They disapproved of the loophole, but rewarded the guy with the wit to exploit it. This, she claims, is very Irish.

The first to take his seat is Bertie Ahern, the prime minister from June 1997 until May 2008 and Political Perp No. 1. Ahern is known both for a native shrewdness and for saying lots of spectacularly dumb-sounding things that are fun to quote. Tony Blair had credited him with a kind of genius in how he brokered the Northern Ireland peace negotiations; on the other hand, seeking to explain the financial crisis, he actually said, “Lehman’s was a world investment bank. They had testicles everywhere.” Ahern spent his last days in office denying he’d accepted bribes from property developers, at least in part because so much of what he did in office seemed justified only if he were being paid by property developers to do it. But Bertie Ahern too obviously believed in the miracle of Irish real estate. After Morgan Kelly published his article predicting the collapse of the Irish banks, for instance, Ahern famously responded to a question about it on national radio by saying, “Sitting on the sidelines, cribbing and moaning is a lost opportunity. I don’t know how people who engage in that don’t commit suicide.”

Now Ahern is just another Irish backbencher, with a hangdog slouch and a face mottled by broken capillaries. To fill the empty hours, he’s taken a job writing a sports column for the Rupert Murdoch tabloid News of the World, which might just be the least respectable job in global journalism. Ahern’s star, such as it was, has fallen.

When the Irish land boom flipped from miracle to catastrophe, a lot of important people’s status, along with perhaps their sense of themselves, flipped with it. An Irish stockbroker told me that many former bankers, some of whom he counts as clients, “actually physically look different.” He’d just seen the former C.E.O. of A.I.B., Eugene Sheehy, in a restaurant, being heckled by other diners. Sheehy once had been a smooth and self-possessed character, whose authority was beyond question. “If you saw the guy now,” says my stockbroker friend, “you’d buy him a cup o’ tea.”

The Irish real-estate bubble was different from the American version in many ways: it wasn’t disguised, for a start; it didn’t require a lot of complicated financial engineering beyond the understanding of mere mortals; it also wasn’t as cynical. There aren’t a lot of Irish financiers or real-estate people who have emerged with a future. In America the banks went down, but the big shots in them still got rich; in Ireland the big shots went down with the banks. Sean Fitzpatrick, a working-class kid turned banker, who built Anglo Irish Bank more or less from scratch, is widely viewed as the chief architect of Ireland’s misfortune: today he is not merely bankrupt but unable to show his face in public. Mention his name and people with no interest in banking will tell you with disgust how he disguised millions of euros in loans made to himself by his own bank. What they don’t mention is what he did with the money: invested it in Anglo Irish bonds! When the bank failed Fitzpatrick was listed among its creditors, having (in April 2008!) purchased five million euros of Anglo Irish subordinated floating-rate notes.

The top executives of the three big banks all operated in a similar spirit: they bought shares in their own companies right up to the moment of collapse, and continued to pay dividends, as if they had capital to burn. Virtually all of the big Irish property developers who behaved recklessly signed personal guarantees for their loans. It’s widely assumed that they must be hiding big piles of money somewhere, but the evidence thus far suggests that they are not. The Irish Property Council has counted at least 29 suicides by property developers and construction workers since the crash—in a country where suicide often goes unreported and undercounted. “I said to all the guys, ‘Always take money off the table.’ Not many of them took money off the table,” says Dermot Desmond, an Irish billionaire, who made his fortune from software in the early 1990s, and so counts here as old money.

The Irish nouveau riche may have created a Ponzi scheme, but it was a Ponzi scheme in which they themselves believed. So too for that matter did some large number of ordinary Irish citizens, who bought houses for fantastic sums. Ireland’s 87 percent rate of home-ownership is among the highest in the world. There’s no such thing as a non-recourse home mortgage in Ireland. The guy who pays too much for his house is not allowed to simply hand the keys to the bank and walk away. He’s on the hook, personally, for whatever he borrowed. Across Ireland, people are unable to extract themselves from their houses or their bank loans. Irish people will tell you that, because of their sad history of dispossession, owning a home is not just a way to avoid paying rent but a mark of freedom. In their rush to freedom, the Irish built their own prisons. And their leaders helped them to do it.

Just before the closing bell, the two men who sold the Irish people on the notion that they, the people, were responsible not merely for their own disastrous financial decisions but also for the ones made by their banks arrive in the chamber: Prime Minister Brian Cowen and Finance Minister Brian Lenihan. Along with the leader of the opposition, and the second in command of their own party, both are offspring of politicians who died in office: Irish politics is a family affair. Cowen happens also to have been the minister of finance from 2004 until mid-2008, when most of the bad stuff happened. He is not an obvious Leader of Men. His movements are sullen and lumbering, his face numbed by corpulence, his natural resting expression a look of confusion. One morning a few weeks before, he went on national radio sounding, to well-trained Irish ears, drunk. To my less trained ones he sounded merely groggy, but the public is in no mood to cut him a break. (Four different Irish people told me, on great authority, that Cowen had faxed Ireland’s 440-billion-euro bank guarantee into the European Central Bank from a pub.) And the truth is, if you were to design a human being to maximize the likelihood that people would assume he drank too much, you’d have a hard time doing better than the Irish prime minister. Lenihan, who follows on Cowen’s bovine heels, comes across, by comparison, as a decathlete in peak condition.

On this day, incredibly yet predictably, the Parliament decides not to hold a vote to fill three of the four empty seats. Then they adjourn, and I spend an hour with Joan Burton. Of the major parties in Ireland, Labour offers the closest thing to a dissenting opinion and a critique of Irish capitalism. As one of only 18 members of the Dáil who voted against guaranteeing the banks’ debts, Burton retains rare credibility. And in an hour of chatting about this and that, she strikes me as straight, bright, and basically good news. But her role in the Irish drama is as clear as Morgan Kelly’s: she’s the shrill mother no one listened to. She speaks in exclamation points with a whiny voice that gets on the nerves of every Irishman—to the point where her voice is parodied on national radio. When I ask her what she would do differently from what the Irish government is doing, even she is stumped. Like every other Irish politician, she is now at the mercy of forces beyond her control. The Irish bank debt is now Irish government debt, and any suggestion of default will only raise the cost of borrowing the foreign money they now can’t live without. “Do you know that Irish people are now experts on bonds?” says Burton. “Yes, they now say 100 basis points rather than 1 percent! They have developed a new vocabulary!”

As the scope of the Irish losses has grown clearer, private investors have been less and less willing to leave even overnight deposits in Irish banks and are completely uninterested in buying longer-term bonds. The European Central Bank has quietly filled the void: one of the most closely watched numbers in Europe has been the amount the E.C.B. has loaned to the Irish banks. In late 2007, when the markets were still suspending disbelief, the banks borrowed 6.5 billion euros. By December of 2008 the number had jumped to 45 billion. As Burton spoke to me, the number was still rising from a new high of 86 billion. That is, the Irish banks have borrowed 86 billion euros from the European Central Bank to repay private creditors. In September 2010 the last big chunk of money the Irish banks owed the bondholders, 26 billion euros, came due. Once the bondholders were paid off in full, a window of opportunity for the Irish government closed. A default of the banks now would be a default not to private investors but a bill presented directly to European governments. This, by the way, is why there are so many important-looking foreigners in Dublin, dining alone at night. They’re here to make sure someone gets his money back.

One measure of how completely the Irish can’t imagine offending their foreign financial rulers is how quickly Burton declines to contemplate such a default. She bears no responsibility for the banks’ private debts, and yet, when we creep up on the possibility of simply walking away from them, she veers off. Actually, she ups and leaves. “Oh, I have to go,” she says. “I have to meet the finance minister with the bad news.” Brian Lenihan has called a private meeting with the opposition, so that its leaders will be the first to hear of the Draconian new Irish budget. This meeting is held not inside the Parliament, where the media can be kept at arm’s length, but in a nearby building, where the media are allowed to congregate. “We tried to have it in here, but he moved it outside,” says Burton. “He’s taken to bringing us in to tell us the bad news first so that when we walk out we’re the ones announcing it to the media.” She smiles. “He’s tricky that way.”

Ireland’s Choice

Brian Lenihan is the last remaining Irish politician anywhere near power whose mere appearance does not cause people on the streets of Dublin to explode with either scorn or laughter. He came to the job just months before the crisis and so escapes blame for its origins. He’s a barrister, not a financial or real-estate person, with a proven ability to earn a good living without being bribed by property developers. He comes from a family of political people who are thought to have served honorably, or at any rate not used politics to enrich themselves. And in December 2009 he was diagnosed with pancreatic cancer. Anyone who has been anywhere near an Irish Catholic family knows the member who has had the most recent run of bad luck enjoys exalted status—the right to do pretty much whatever he wants, while everyone else squirms in silence. Since news of Lenihan’s illness broke—just days after he’d learned of it himself, rushing him into telling his children—he has minimized his suffering. Underlying the public-opinion polls that show the Irish feel a lot better about the minister of finance than they do about other politicians in his party is a common, unspoken understanding of his bravery.

Brian Lenihan is also, as Joan Burton points out, tricky. It’s racing up on eight in the evening when I meet him in a Department of Finance conference room. He has spent most of his day defending the harshest spending cuts and tax hikes in Irish history to Irish politicians, without offering any details about who, exactly, will pay for the banks’ losses. (He’s waiting to do that until after the single by-election the Dáil authorized is held.) He smiles. “Why is everyone so interested in Ireland?” he asks almost innocently. “There’s really far too much interest in us right now.”

“Because you’re interesting?” I say.

“Oh no,” he says seriously. “We’re not, really.”

He proceeds to make the collapse of the Irish economy as uninteresting as possible. This awkward social responsibility—normalizing a freak show—is now a meaningful part of the job of being Ireland’s finance minister. At just the moment the crazy uncle leapt from the cellar, the drunken aunt lurched through the front door and, in front of the entire family and many important guests, they carved each other to bits with hunting knives. Daddy must now reassure eyewitnesses that they didn’t see what they think they saw.

But the physical evidence that something deeply weird just happened in Ireland is still too conspicuous. A mile from the conference table where we take our seats is a moonscape of vast, two-year-old craters from which office parks were once meant to rise. There are fully finished skyscrapers that sit empty, water pooling on their lobby floors. There’s a skeleton of a tower, cranes resting on either side like parentheses, which was meant to house Anglo Irish Bank. There’s a city dump for which a developer paid 412 million euros in 2006—and which is now, when you include the cleanup costs, valued at zero. “Ireland is very unusual,” says William Newsom, who has more than 30 years of experience valuing commercial real estate for Savills in London. “There are whole swaths of either undeveloped land with planning permission or even partially developed sites which, I believe, for practical purposes have zero value.” The peak of the Irish madness is frozen in time, for all to see. There’s even an empty Starbucks, in the heart of what was meant to be a global financial center to rival London’s, where a carton of low-fat milk curdles beside a silver barista pitcher. The finance minister might as well be standing in Pompeii and saying that actually the volcano wasn’t really worth mentioning. Just a little lava!

“This isn’t Iceland” is what Lenihan actually says. “We’re not a hedge fund that’s populated by 300,000 farmers and fishermen. Ireland is not going back to the 80s or the 90s. This is all in a much narrower band.” And then he goes off on a soliloquy, the main point of which is: Ireland’s problems are solvable, and I am in control of the situation.

Back in September 2008, however, there was evidence that he wasn’t. On September 17 the financial markets were in turmoil. Lehman Brothers had failed two days earlier, shares of Irish banks were plummeting, and big corporations were withdrawing their deposits from them. Late that evening Lenihan phoned David McWilliams, a former senior European economist with UBS in Zurich and London, who had moved back home to Dublin and turned himself into a writer and media personality. McWilliams had been loudly skeptical about the Irish real-estate boom. Two weeks earlier he had appeared on a radio show with Lenihan, and Lenihan appeared to him entirely untroubled by the turmoil in the financial markets. Now he wanted to drive out to McWilliams’s house and ask his advice on what to do about the Irish banks.

The peculiar scene is described in McWilliams’s charmingly indiscreet book, Follow the Money. Lenihan arrives at the McWilliams residence, a 45-minute drive from Dublin, marches through to the family kitchen, and pulls a hunk of raw garlic out of his jacket pocket. “He kicked off by saying if his officials knew he was here in my house, there’d be war,” writes McWilliams. The finance minister stayed until two in the morning, drinking tea and anxiously picking McWilliams’s brain. McWilliams came away with the feeling that the minister didn’t entirely trust the advice he was getting from the people around him—and that he was not merely worried but confused. McWilliams told me that he sensed that the mental state of the Department of Finance was “complete chaos.”

A week later the department hired investment bankers from Merrill Lynch to advise it. Some might say that if you were asking Merrill Lynch for financial advice in 2008 you were already beyond hope, but that is not entirely fair. The bank analyst who had been most prescient and interesting about the Irish banks worked for Merrill Lynch. His name was Philip Ingram. In his late 20s, and a bit quirky—at the University of Cambridge he had studied zoology—Ingram had done something original and useful: he’d shined a new light on the way Irish banks lent against commercial real estate.

The commercial-real-estate loan market is generally less transparent than the market for home loans. Deals between bankers and property developers are one-offs, on terms unknown to all but a few insiders. The parties to any loan always claim it is prudent: a bank analyst has little choice but to take them at their word. But Ingram was skeptical of the Irish banks. He had read Morgan Kelly’s newspaper articles and even paid Kelly a visit in his university office. To Ingram’s eyes, there undoubtedly appeared to be a vast difference between what the Irish banks were saying and what was really happening. To get at it he ignored what they were saying and went looking for knowledgeable insiders in the commercial-property market. He interviewed them, as a journalist might. On March 13, 2008, six months before the Irish real-estate Ponzi scheme collapsed, Ingram published a report, in which he simply quoted verbatim what British market insiders had told him about various banks’ lending to commercial real estate. The Irish banks were making far riskier loans in Ireland than they were in Britain, but even in Britain, the report revealed, they were the nuttiest lenders around: in that category, Anglo Irish, Bank of Ireland, and A.I.B. came, in that order, first, second, and third.

For a few hours the Merrill Lynch report was the hottest read in the London financial markets, until Merrill Lynch retracted it. Merrill had been a lead underwriter of Anglo Irish’s bonds and the corporate broker to A.I.B.: they’d earned huge sums of money off the growth of Irish banking. Moments after Phil Ingram hit the Send button on his report, the Irish banks called their Merrill Lynch bankers and threatened to take their business elsewhere. The same executive from Anglo Irish who had called to scream at Morgan Kelly called a Merrill research analyst to scream some more. Ingram’s superiors at Merrill Lynch hauled him into meetings with in-house lawyers, who toned down the report’s pointed language and purged it of its damning quotes from market insiders, including its many references to Irish banks. And from that moment everything Ingram wrote about Irish banks was edited, and bowdlerized by Merrill Lynch’s lawyers. At the end of 2008, Merrill fired him. One of Ingram’s colleagues, a fellow named Ed Allchin, was also made to apologize to Merrill’s investment bankers individually for the trouble he’d caused them by suggesting there was still money to be made on shorting Irish banks.

It would have been difficult for Merrill Lynch’s investment bankers not to know, at some level, that in a reckless market the Irish banks had acted with a recklessness all their own. But in the seven-page memo to Brian Lenihan—for which the Irish taxpayer forked over to Merrill Lynch seven million euros—they kept whatever reservations they may have had to themselves. “All of the Irish banks are profitable and well capitalised,” wrote the Merrill Lynch advisers, who then went on to suggest that the banks’ problem wasn’t at all the bad loans they had made but the panic in the market. The Merrill Lynch memo listed a number of possible responses the Irish government might have to any run on Irish banks. It refrained from explicitly recommending one course of action over another, but its analysis of the problem implied that the most sensible thing to do was guarantee the banks. After all, the banks were fundamentally sound. Promise to eat all losses, and markets would quickly settle down—and the Irish banks would go back to being in perfectly good shape. As there would be no losses, the promise would be free.

What exactly was said in meetings on the night of September 29, 2008, remains, amazingly, something of a secret. The government has refused Freedom of Information Act-type requests for records. But gathered around the conference tables inside the prime minister’s offices was an array of top government and finance officials, including Lenihan, Cowen, the attorney general, and bank officials and regulators. Eventually they brought in the heads of the two yet-to-be-disgraced big Irish banks: A.I.B. and Bank of Ireland. Evidently they either lied to Brian Lenihan about the extent of their losses or didn’t know themselves what those were. Or both. “At the time they were all saying the same thing,” an Irish bank analyst tells me. “ ‘We don’t have any subprime.’ ” What they meant was that they had avoided lending to American subprime borrowers; what they neglected to mention was that, in the general frenzy, all of Ireland had become subprime. Otherwise sound Irish borrowers had been rendered unsound by the size of the loans they had taken out to buy inflated Irish property. That had been the strangest consequence of the Irish bubble: to throw a nation which had finally clawed its way out of centuries of indentured servitude back into it.

The report from Merrill Lynch, which touted the banks as fundamentally sound, buttressed whatever story they told the finance minister. Ireland’s financial regulator, Patrick Neary, had echoed Merrill’s judgment. Morgan Kelly was still viewed as a zany egghead; at any rate, no one who took him seriously was present in the room. Anglo Irish’s stock had fallen 46 percent that day; A.I.B.’s had fallen 17 percent; there was a fair chance that when the stock exchange reopened one or both of them would go out of business. In the general panic, absent government intervention, the other banks would have gone down, too. Lenihan faced a choice: Should he believe the people immediately around him or the financial markets? Should he trust the family or the experts? He stuck with the family. Ireland gave its promise. And the promise sank Ireland.

Even at the time, the decision seemed a bit odd. The Irish banks, like the big American banks, managed to persuade a lot of people that they were so intertwined with their economy that their failure would bring down a lot of other things, too. But they weren’t, at least not all of them. Anglo Irish Bank had only six branches in Ireland, no A.T.M.’s, and no organic relationship with Irish business except the property developers. It lent money to people to buy land and build: that’s practically all it did. It did this mainly with money it had borrowed from foreigners. It was not, by nature, systemic. It became so only when its losses were made everyone’s.

In any case, if the Irish wanted to save their banks, why not guarantee just the deposits? There’s a big difference between depositors and bondholders: depositors can flee. The immediate danger to the banks was that savers who had put money into them would take their money out, and the banks would be without funds. The investors who owned the roughly 80 billion euros of Irish bank bonds, on the other hand, were stuck. They couldn’t take their money out of the bank. And their 80 billion euros very nearly exactly covered the eventual losses inside the Irish banks. These private bondholders didn’t have any right to be made whole by the Irish government. The bondholders didn’t even expect to be made whole by the Irish government. Not long ago I spoke with a former senior Merrill Lynch bond trader who, on September 29, 2008, owned a pile of bonds in one of the Irish banks. He’d already tried to sell them back to the bank for 50 cents on the dollar—that is, he’d offered to take a huge loss, just to get out of them. On the morning of September 30 he awakened to find his bonds worth 100 cents on the dollar. The Irish government had guaranteed them! He couldn’t believe his luck. Across the financial markets this episode repeated itself. People who had made a private bet that went bad, and didn’t expect to be repaid in full, were handed their money back—from the Irish taxpayer.

In retrospect, now that the Irish bank losses are known to be world-historically huge, the decision to cover them appears not merely odd but suicidal. A handful of Irish bankers incurred debts they could never repay, of something like 100 billion euros. They may have had no idea what they were doing, but they did it all the same. Their debts were private—owed by them to investors around the world—and still the Irish people have undertaken to repay them as if they were obligations of the state. For two years they have labored under this impossible burden with scarcely a peep of protest. What’s more, all of the policy decisions since September 29, 2008, have set the hook more firmly inside the mouths of the Irish public. In January 2009 the Irish government nationalized Anglo Irish and its 34-billion-euro (and mounting) losses. In late 2009 they created the Irish version of the tarp program, but, unlike the U.S. government (which ended up buying stakes in the banks), they actually followed through on the plan and are in the process of buying 70 billion euros of crappy assets from the Irish banks.

A single decision sank Ireland, but when I ask Lenihan about it he becomes impatient, as if it isn’t a fit topic for conversation. It wasn’t much of a decision, he says, as he had no choice. The Irish financial markets are governed by rules rooted in English law, and under English law bondholders enjoy the same status as ordinary depositors. That is, it was against the law to protect the little people with deposits in the bank without also saving the big investors who owned Irish bank bonds.

This rings a bell. When U.S. Treasury secretary Hank Paulson realized that allowing Lehman Brothers to fail was viewed not as brave and principled but catastrophic, he, too, claimed he’d done what he’d done because the law gave him no other option. But in the heat of the crisis, Paulson had neglected to mention the law just as Lenihan didn’t bring up the law requiring him to pay off the banks’ private lenders until long after he’d done it. In both cases the explanation was legalistic: narrowly true, but generally false. The Irish government always had the power to impose losses on even the senior bondholders, if it wanted to. “Senior people have forgotten that the government has certain powers,” as Morgan Kelly puts it. “You can conscript people. You can send them off to certain death. You can change the law.”

On September 30, 2008, in the heat of the moment, Lenihan gave the same reason for guaranteeing the banks’ debts that Merrill Lynch had given him: to prevent “contagion.” Tell financial markets that a loan to an Irish bank was a loan to the Irish government and investors would calm down. For who would doubt the credit of the government? A year and a half later, when suspicions arose that the banks’ losses were so vast they might bankrupt the government, Lenihan offered a new reason for the government’s gift to private investors: the bonds were owned by Irishmen. Up until then the government’s line had been that they had no idea who owned the bank’s bonds. Now they said that, if the Irish government didn’t eat the losses, Irish credit unions and insurance companies would pay the price. The Irish, in other words, were simply saving the Irish. This wasn’t true, and it provoked a cry of outrage from the credit unions, which said that they owned hardly any of the bonds. A political investigative blog called Guido Fawkes somehow obtained a list of the Anglo Irish foreign bondholders: German banks, French banks, German investment funds, Goldman Sachs. (Yes! Even the Irish did their bit for Goldman.)

Across Europe just now men who thought their title was “minister of finance” have woken up to the idea that their job is actually government bond salesman. The Irish bank losses have obviously bankrupted Ireland, but the Irish finance minister does not want to talk about that. Instead he mentions to me, several times, that Ireland is “fully funded” until next summer, which is to say that the Irish government has enough cash in the bank to pay its bills until next July. It isn’t until I’m on my way out the door that I realize how trivial this point is. The blunt truth is that, since September 2008, Ireland has been, every day, more at the mercy of her creditors. To remain afloat, Ireland’s biggest banks, which are now owned by the Irish government, have taken short-term loans from the European Central Bank amounting to 86 billion euros. Two weeks later Lenihan will be compelled by the European Union to invite the I.M.F. into Ireland, relinquish control of Irish finances, and accept a bailout package. The Irish public doesn’t yet know it, but, even as we sit together at his conference table, the European Central Bank has lost interest in lending to Irish banks. And soon Brian Lenihan will stand up in the Irish Parliament and offer a fourth explanation for why private investors in Ireland’s banks cannot be allowed to take losses. “There is simply no way that this country, whose banks are so dependent on international investors, can unilaterally renege on senior bondholders against the wishes of the E.C.B.,” he will say.

But there was once a time when the wishes of the E.C.B. didn’t matter to Ireland. That time was before the Irish government used E.C.B. money to pay off the foreign bondholders in Irish banks.

Bring Me a Little Ire
Once a decade I experiment with driving on the wrong side of the road, and wind up destroying dozens of side-view mirrors on cars parked on the left. When I went looking for some Irish person to drive me around, the result was a fellow I will call Ian McRory (he asked me not to use his real name in this article), who is Irish, and a driver, but pretty clearly a lot of other things, too. Ian has what appears to be a military-grade navigational system, for instance, and surprising knowledge about abstruse and secretive matters. “I do some personal security, and things of that nature,” he says, when I ask him what else he does other than drive financial-disaster tourists back and forth across Ireland, and leaves it at that. Later, when I mention the name of a formerly rich Irish property developer, he says, casually, as if it were all in a day’s work, that he had let himself into the fellow’s vacation house and snapped photographs of the interior, “for a man I know who is thinking of buying it.”

Ian turns out to have a good feel for what I, or anyone else, might find interesting in rural Ireland. He will say, for example, “Over there, that’s a pretty typical fairy ring,” and then explain, interestingly, that these circles of stones or mushrooms that occur in Irish fields are believed by local farmers to house mythical creatures. “Irish people actually believe in fairies?,” I ask, straining but failing to catch a glimpse of the typical fairy ring to which Ian has just pointed. “I mean, if you walked right up and asked him to his face, ‘Do you believe in fairies?’ most guys will deny it,” he replies. “But if you ask him to dig out the fairy ring on his property, he won’t do it. To my way of thinking, that’s believing.” And it is. It’s a tactical belief, a belief that exists because the upside to disbelief is too small, like the former Irish belief that Irish land prices would rise forever.

The highway out of Dublin runs past abandoned building sites and neighborhoods without people in them. “We can stop at ghost estates on the way,” says Ian, as we clear the suburbs of Dublin. “But if we stop at every one of them, we’ll never get out of here.”

We pass wet green fields carved by potato farmers into small plots, and every now and then a small village, but even the inhabited places feel desolate. The Irish countryside remains a place people flee. Among its drawbacks, from the outsider’s point of view, is the weather. “It’s always either raining or about to rain,” says Ian. “I drove a black guy from Africa around the country once. It’s raining the whole time. He says to me, ‘I don’t know why people live here. It’s like living under an elephant.’ ”

The wet hedgerows cultivated along the highway to hide the wet road from the wet houses now hide the wet houses from the wet road. picture of the village of the future, reads a dripping billboard with a picture of a village that will never be built. Randomly selecting a village that appears to be more or less finished, we pull off the road. It’s an exurb, without a suburb. GLEANN RIADA, reads the self-important sign in front. It’s a few dozen houses in a field, attached to nothing but each other, ending with unoccupied slabs of concrete buried in weeds. You can see the moment the money stopped flowing from the Irish banks, the developer folded his tent, and the Polish workers went home. “The guys who laid this didn’t even believe it was supposed to be finished,” says Ian. The concrete slab, like the completed houses, is riven by the kind of cracks you see in a house after a major earthquake, but in this case are caused by carelessness. Inside, the floors are littered with trash and debris, the fixtures have been ripped out of the kitchen, and mold spreads spider-like across the walls. The last time I saw an interior like this was in New Orleans after Katrina.

In October, Ireland’s Department of the Environment published its first audit of the country’s new housing stock after inspecting 2,846 housing developments, many of them called “ghost estates” because they’re empty. Of the nearly 180,000 units that had been granted planning permission, the audit found that only 78,195 were completed and occupied. Others are occupied but remain unfinished. Virtually all construction has now ceased. There aren’t enough people in Ireland to fill the new houses; there were never enough people in Ireland to fill the new houses. Ask Irish property developers who they imagined was going to live in the Irish countryside, and they all laugh the same uneasy laugh and offer up the same list of prospects: Poles; foreigners looking for second homes; entire departments of Irish government workers, who would be shipped to the sticks in a massive, planned relocation that somehow never materialized; the diaspora of 70 million human beings with a genetic link to Ireland. The problem that no one paid all that much attention to during the boom was that people from outside Ireland, even those with a genetic link to the place, have no interest in owning houses there. “This isn’t an international property market,” says an agent at Savills’s Dublin branch named Ronan O’Driscoll. “There aren’t any foreign buyers. There were never foreign buyers.” Dublin was never London. The Irish countryside will never be the Cotswolds.

Which way entire nations jumped when the money was made freely available to them obviously told you a lot about them: their desires, their constraints, their secret sense of themselves. How they reacted when the money was taken away was equally revealing. In Greece the money was borrowed by the state: the debts are the debts of the Greek people, but the people want no part of them. The Greeks already have taken to the streets, violently, and have been quick to find people other than themselves to blame for their problems: monks, Turks, foreign bankers. Greek anarchists now mail bombs to Angela Merkel and hurl Molotov cocktails at their own police. In Ireland the money was borrowed by a few banks, and yet the people seem not only willing to repay it but to do so without a peep of protest. Back in October 2008, after the government threatened to means-test for medical care, the old people marched in the streets of Dublin. A few days after I’d arrived the students followed suit, but their protest was less public anger than theater, and perhaps an excuse to skip school. (DOWN WITH THIS SORT OF THING, read one of the students’ signs.) I’d tapped two students as they stumbled away from the event to ask why they had all painted yellow streaks on their faces. They looked at each other for a beat. “Dunno!” one finally said and burst out laughing. Other than that … silence. It’s more than two years since the Irish government foisted the losses of the Irish banks on the Irish people, and in that time there have been only two conspicuous acts of social unrest. In May 2009, at A.I.B.’s first shareholder meeting after the collapse, a senior citizen hurled rotten eggs at the bank’s executives. And early one morning in September 2010, a 41-year-old property developer from Galway named Joe McNamara, who had painted his cement mixer with anti-banker slogans, climbed inside the cab, drove through Dublin, and, after cutting the brake lines, stalled the machine up against the gates of the Parliament. The elderly egg thrower was a distant memory, but McNamara was still, more or less, in the news: declining requests for interviews. “Joe is a private person,” his lawyer told me. “He feels like he’s made his point. He doesn’t want any media attention.”

Before he’d parked his cement mixer in the Parliament’s driveway, McNamara had been a small-time builder. He’d started out laying foundations, and like a lot of rural tradesmen, he’d been given a loan by the Anglo Irish Bank. Thus began his career as a property developer. He’d moved to Galway, into a tacky new development beside a golf course, but the real source of his financial distress lay an hour or so beyond the city, in a resort hotel he’d tried to build on a remote island called Achill, in the tiny village in which he’d grown up, called Keel. “Achill,” says Ian after I tell him that’s where I’d like to go, then goes silent for a minute, as if giving me time to reconsider. “This time of year Achill’s going to be fairly bleak.” He thinks another minute. “Mind you, in the summer it can be fairly bleak as well.”

It’s twilight as we roll across the tiny bridge and onto the island. On either side of the snaking single-lane road peat bogs stretch as far as the eye can see. The feel is less “tourist destination” than “end of the earth.” (“The next stop is Newfoundland,” says Ian.) The Achill Head Hotel—Joe’s first venture, still run by his ex-wife—was closed and dark. But there, smack in the middle of the tiny village of Keel, was the source of all of Joe McNamara’s financial troubles: a giant black hole, surrounded by bulldozers and building materials. He’d set out in 2005 to build a modest one-story hotel, with 12 rooms. In April 2006, with the Irish property market exploding, he’d expanded his ambition and applied for permission to build a multi-story luxury hotel. At exactly that moment, the market turned. “We went away in June of 2006,” Ronan O’Driscoll, the Savills broker, had told me. “We came back in September and everything had just stopped. How does everyone decide at once that it is time to stop—that it’s become mad?” For the past four years the hotel’s site had scarred the village. But it wasn’t until early 2010 that Anglo Irish Bank, which had lent McNamara the money to develop it, threatened to force him into receivership. Irish bankruptcy laws were not designed for spectacular failure, perhaps because the people who wrote them never imagined spectacular success. When a bank forces an Irish person into receivership, a notice is published in a national and a local newspaper—ensuring the bankrupt’s widespread shame. For as many as 12 years the person is not permitted to take out a loan for more than 650 euros without disclosing his bankruptcy status or own assets amounting to more than 3,100 euros, and part of whatever he earns may pass to his creditors at the discretion of the court. “It’s not like the United States, where being bankrupt is almost a badge of honor,” says Patrick White, of the Irish Property Council. “Here you are effectively disbarred from commercial life.”

There is an ancient rule of financial life—that if you owe the bank five million bucks the bank owns you, but if you owe the bank five billion bucks you own the bank—that newly applies to Ireland. The debts of its big property developers—now generally defined as anyone who owed the bank more than 20 million euros—are being worked out behind closed doors. In exchange for helping the government to manage or liquidate their real-estate portfolios, the biggest failures are hoping to be spared bankruptcy. Smaller developers, like McNamara, are in a far harder place, and while no one seems to know how many of these people exist, the number is clearly big.

Ireland’s National Asset Management Agency (its tarp) controls roughly 70 billion euros of commercial-property loans. It is believed that smaller Irish property-related loans amount to another 85 billion euros. Some very large number of Irish former tradesmen are in exactly Joe McNamara’s situation. Some very large number of Irish homeowners are in something very like it.

The difference between McNamara and everyone else is that he complained about it publicly. But then, apparently, thought better of it. I’d tracked down and phoned his ex-wife, who just laughed and told me to get lost. I finally reached McNamara himself, ambushing him on his cell phone. But he just muttered something about not wanting to draw further attention to himself, then hung up. It was only after I texted him to say I was en route to his hometown that he became sufficiently aroused to communicate. “What are you doing in Keel????” he hollered by text message, more than once. “Tell me Why are you going to Keel???” Then, once again, he fell silent. “The problem with the Irish people,” Ian says, as we drive away from the black hole that ruined Joe McNamara, “is that you can push them and push them and push them. But when they break they go wacko.” A month later, after a period of silence, McNamara would reappear, blasting the theme from The Good, the Bad and the Ugly from the top of a cherry-picker crane that he had parked, once again, in front of the Parliament.

Two things strike every Irish person when he comes to America, Irish friends tell me: the vastness of the country, and the seemingly endless desire of its people to talk about their personal problems. Two things strike an American when he comes to Ireland: how small it is and how tight-lipped. An Irish person with a personal problem takes it into a hole with him, like a squirrel with a nut before winter. He tortures himself and sometimes his loved ones too. What he doesn’t do, if he has suffered some reversal, is vent about it to the outside world. The famous Irish gift of gab is a cover for all the things they aren’t telling you.

So far as I could see, by November 10, 2010, the population of Irish people willing to make a stink about what has happened to them has been reduced to one: the elderly egg thrower. The next day we pull up outside his home, a modest old semi-detached house on the outskirts of Dublin. The cheery gentleman who opens the door in a neat burgundy sweater and well-pressed slacks has, among his other qualities, fantastically good manners. He has the ability to seem pleased even when total strangers ring his doorbell, and to make them feel welcome. On the table in Gary Keogh’s small and tidy dining room is a book, created by his grandchildren, dated May 2009, called “Granddad’s Eggcellent Adventure.”

In the months after Lenihan’s bank bailout, Keogh began to pay attention to the behavior of Irish bankers. His own shares in A.I.B., once thought to be as sound as cash or gold, were rapidly becoming worthless. But the bank’s executives exhibited not the first hint of remorse or shame. A.I.B. chairman Dermot Gleeson and C.E.O. Eugene Sheehy troubled Keogh the most. “The two of ’em stood up, time and again, and said, ‘Our bank is 100 percent sound,’ ” he says. “As if nothing at all was the matter!” He set out to learn more about these people in whom he had always placed blind trust. And what he found—high pay, corporate boondoggles—outraged him further. “The chairman paid himself 475,000 [euros] to chair 12 meetings!” Keogh still shouts.

What Keogh learned remains both the most shocking and the most familiar aspect of the Irish catastrophe: how easily ancient financial institutions abandoned their traditions and principles. An upstart bank, Anglo Irish, had entered their market and professed to have found a new and better way to be a banker. Anglo Irish made incredibly quick decisions: an Irish property developer who was an existing client could walk into its office in the late afternoon with a new idea and walk out with a commitment of hundreds of millions of euros that night. Anglo Irish was able to shovel money out its door so quickly because it had turned banking into a family affair: if they liked the man, they didn’t bother to evaluate his project.

Rather than point out the insanity of the approach, the two old Irish banks simply caved to it. An Irish businessman named Denis O’Brien sat on the board of the Bank of Ireland in 2005, when it was faced with the astonishing growth of Anglo Irish, which was about to double in size in just two years. “I remember the C.E.O. coming in and saying, ‘We’re going to grow at 30 percent a year,’ ” O’Brien tells me. “I said, How the fuck are you going to do that? Banking is a 5-to-7-percent-a-year-growth business at best.”

They did it by doing what Anglo Irish had done: writing checks to Irish property developers to buy Irish land at any price. A.I.B. even opened a unit dedicated to poaching Anglo’s biggest property-developer clients—the very people who would become the most spectacular busts in Irish history. In October 2008, the Irish Independent published a list of the five biggest real-estate deals in each of the past three years. A.I.B. lent the money for 6 of the 15, Anglo Irish for just 1, as a co-lender with A.I.B. On Irish national radio recently, the insolvent property developer Simon Kelly, whose family’s real-estate portfolio has run up bad debts of 2 billion euros, confessed that the only time in his career a banker became upset with him was when he repaid a loan, to Anglo Irish, with money borrowed from A.I.B. The former Anglo Irish executives I interviewed (off the record, as they are all in hiding) speak of their older, more respectable imitators with a kind of amazement. “Yes, we were out of control,” they say, in so many words. “But those guys were fucking nuts.”

Gary Keogh thought about how Ireland had changed from his youth, when the country was dirt-poor. “I used to collect bottles. Now the health service doesn’t even bother to take back crutches anymore? No! We’re far too wealthy.”

Unlike most people he knew, he had no debts. “I had nothing to lose,” he says. “I didn’t owe anyone any money. That’s why I could do it!” He’d also just recovered from a serious illness, and so, emotionally, felt a bit as if he were playing with house money. “I had just got a new kidney and I was very pleased with it,” he says. “But I think it must have been Che Guevara’s kidney.” He describes his elaborate plot the way an assassin might describe the perfect hit. “I only had two rotten eggs,” he says, “but by God they were rotten! Because I kept them six weeks in the garage!”

The A.I.B. shareholders’ meeting of May 2009 was the first he’d ever attended. He was, he admits, a bit worried something might go wrong. Worried that parking might be a problem, he took the bus; worried that his eggs might break, he used a container to protect them; worried that he didn’t even know what the room looked like, he left himself time to case the meeting hall. “I got to the front door early and had a little recce,” as he puts it, “just to see what was going to happen.” His egg container was too large to sneak inside, so he ditched it. “I had one egg in each jacket pocket,” he says. Worried that his eggs might be too slippery to grip and throw, he’d put Band-Aids on them. “I positioned myself four rows back and four seats in,” he says. “Not too close but not too far.” Then he waited for his moment.

It came immediately. Right after the executives took their places at the dais, a shareholder stood up, uninvited, with a point of order. Gleeson, A.I.B.’s chairman, barked, “Sit down!”

“He thought he was a dictator!” says Keogh, who had heard enough.

He rose to his feet and shouted, “I’ve listened to enough of your crap! You’re a fucking git!” And then he began firing.

“He thought he had been shot,” he says now with a little smile, “because the first egg hit the microphone and went POW!” It splattered onto the shoulder pad of Gleeson’s suit. The second egg missed the C.E.O. but nailed the A.I.B. sign behind him.

Then the security guards were on him. “I was told I would be arrested and charged, but I never was,” he says. Of course he wasn’t: this was at bottom a family dispute. The guards wanted to escort him out, but he left the place on his own and climbed aboard the next bus home. “The incident happened at 10 past 10 in the morning,” he says. “I was home by 10 to 11. At 10 past 11 the phone rang. And I was on the radio for an hour.” Then, but briefly, all was madness. “The press descended on the house and they wouldn’t get out,” he says. It didn’t really matter; he wasn’t sticking around. He’d done exactly what he’d planned to do, and saw no need to make a further fuss. He flew out of Dublin Airport at seven the next morning, for a long-planned Mediterranean cruise.

Vietnam struggles to keep pace with surging power demand

2011-02-25T00:19:00.000-08:00

Low water levels at Vietnam’s hydroelectric plants are combining with rapid demand growth and delays in new capacity build to create growing power shortages across the country. Faced with this deteriorating situation the government is beginning to introduce long overdue reform, and is raising prices, to attract much needed investment.

February 21st, 2011 by Jeremy Bowden

A perfect storm is developing in Vietnam’s power sector as a series of events converge to challenge state electric utility, Electricity de Vietnam’s (EVN) ability to meet the needs of its fast growing economy. Vietnam’s Ministry of Industry and Trade, says that the total output of new power plants commissioned in 2010 was less than half the target of about 5000MW. This year EVN says water levels at its main hydroelectric plants are averaging about 35% below normal, as the country enters its six month dry season. The first half of 2011 is now expected to see up to 1.4TWh less hydroelectric output than planned, according to EVN’s (often optimistic) forecasts. At the same time, EVN is projecting that national power demand will surge again in 2011, by over 16% to 117TWh.

Overall there is expected to be a shortfall in 2011of at least twice 2010’s figure of 1.39TWh, which caused disruption and widespread power cuts, and forced EVN to buy expensive diesel in an attempt to make up some of the shortfall.

Ta Van Huong, head of the Energy Department under the Ministry of Industry and Trade, says the key reason behind the power crunch is that investment lags behind demand growth. EVN itself has always blamed low power prices for delays in both capacity expansion and power cuts. It says it is this lack of income that has constrained investment and suppressed profitability.

The result is a company starved of funds. In 2010 EVN incurred losses of about VND8tn (US$400m: @ US$1 about VND20,000), according to its board chairman. This, coupled with unpaid debts and other financial arrears, leaves the corporation effectively mired in almost VND25tn of debt.

This year EVN says it no longer has the resources to supplement generation capacity with diesel generators. Diesel prices are much higher this year than last, and it estimates VND5.4tn would be needed to buy diesel for the dry season alone, and VND12tn for the whole year.

The low prices have also increased demand beyond what had been anticipated, by attracting overseas steel and cement plants – which go on to export most of their production. Steel and cement use about 12% of output, according to EVN. A recent report from Vietnam’s Ministry of Industry and Trade shows that about 65 new steel plants since 2007, far more than the 23 projects estimated in a development plan for the industry approved three years ago by the government. Driven by economic growth targets some regions have not adhered to the plans, resulting in an influx of energy intensive industries and a consequent underestimate of power demand growth.

So, with nationwide power cuts biting earlier in the year than ever before and no relief in sight, the Vietnamese government is considering a record increase in the price of electricity. Late last year EVN gained government support for the introduction of a new pricing structure, to enable it to pass on higher generation costs on to consumers. Recent reports in the state media suggest price rises could be in the order of 15%. Currently prices are about VND1000 or US¢5/kWh – compared to the much higher levels of US¢12-15/kWh in neighboring Thailand and Cambodia. There has also been agreement on the introduction of long awaited reforms to build-operate and transfer (BOT) projects to make the sector more attractive to independent power producers (IPPs).

Vietnam’s power infrastructure: straining to cope with racing growth.

But low prices are not the only problem. Years of central planning by Soviet-trained officials has left a legacy of often unresponsive and bureaucratic state monopolies and central government. Although market-orientated technocrats are beginning to take over, many essential areas of the economy – from oil refineries to power plants – are failing to keep pace with the country’s growing needs, imposing heavy costs on the economy. In the case of the power sector, the government’s hand is now being forced in the face of unacceptable shortages.

In principle power reform has been underway since 2000, when a policy of “unbundling” generation, transmission and distribution was apparently adopted, along with the introduction of full competition by 2020. But in reality little has changed so far, apart from the replacement of five-year plans with mission statements and other western corporate jargon.

In 2005 the Ministry of Industry declared 15 independent power producer (IPP) projects open for foreign investment. The aim was to raise the share of electricity purchased from IPPs from 14% in 2005 to 33% by 2010. But progress has been constrained by disagreements over pricing.

Nevertheless, the proportion of electricity purchased from IPPs has still risen to the 33% target, but only because EVN has also failed to meet targets for its own capacity expansion. In the first eleven months of 2010 Vietnam had access to almost 90TWh of grid power. EVN produced 54TWh from its own plants, bought almost 30 TWh from independent power producers and captive generators, and imported about 5TWh from China, according to company data.

The ministry says that for this year, the target of commissioning new plants with a combined output of 5400MW looks impossible. Four out of ten projects scheduled to begin last year have been delayed to this year, and only 11 of 33 projects under construction are progressing to plan.

The introduction late last year of uniform criteria for build-operate-transfer (BOT) projects has already led to greater enthusiasm from IPP consortium. More than 12GW of coal-fired plants are expected to begin this year (see examples below), indicating that Vietnam may be on course to tackle mid-term power supply shortages. However, Prime Minister Nguyen Tan Dung and Vietnam’s other economic reformers could pay a price for these essential reforms, as sharply higher power costs will not be popular with consumers.

What’s more, serious management reforms must follow at EVN to ensure the sector’s healthy development. And even if prices are raised 15% or more, this will only address mid to long term supply, as delays are unlikely to be made up. This leaves the energy-thirsty economy with little alternative but to brace itself for shortages – or produce its own power.

Some existing IPPs are also demanding higher prices from EVN, which buys all the power entering the national grid. State mining firm Vietnam National Coal and Mineral Industries Group (Vinacomin) is lobbying the government to increase prices paid for power from its 110MW Na Duong plant to VND757/kWh and VND790/kWh from its 110MW Cao Ngan plant. Vietnam’s MIT says power prices should guarantee a return to the producer of 10-15%, but none have reached this level according to Vinacomin Power deputy director general, Nguyen Duc Thao.

Vinacomin’s two plants currently sell through 25 year deals at VND620 and VND655/kWh. Vinacomin has successfully renegotiated prices before, but the prospect for private IPPS is bleak. For example, low water levels are undermining IPP VRG-Bao Loc, which runs a 24.5MW hydro plant. Its deal to sell at VND682/kWh is uneconomic at the reduced flow rate, leaving it unable to pay off debt.

Despite EVN’s problems there have been some successes, notably at southeast Asia’s largest hydropower facility of Son La, where the first 400MW turbine began supplying electricity to the national grid in mid-December – two years ahead of schedule. The five other turbines comprising the 2400MW project are expected to go online by the end of 2012 – three years ahead of schedule.

Son La’s success came shortly before the start of construction at the 1200MW Lai Chau plant – the country’s third-largest hydroelectric power plant after Son La and the already operational 1920MW Hoa Binh facility. All three plants are located on the Da River. Lai Chau will be the highest of the three plants, preceding Son La and then Hoa Binh as the river flows downstream.

It is projected to supply an average of 4.7 TWh/year to the grid on its scheduled completion in 2017. The project has a total capital cost of VND32.5tn, or about US$1600/kW. EVN said in mid-December that it was also aiming to start operating the first turbines at the Song Tranh 2 and Dong Nai 3 hydroelectric projects by the end of the month. The 190MW Song Tranh 2 project on the Tranh River began construction in March 2006, while the 180MW Dong Nai 3 project in Lam Dong province began construction in December 2004.

Coal to take the lead

As opportunities for hydro power are exhausted and water levels become increasingly uncertain, expansion plans are focusing on coal fired generation – as is the case over much of Asia. Coal-fired plants account for about 12% of Vietnam’s 18.5GW capacity, and this is expected to rise to 32.3GW by 2020, overtaking gas and hydropower.

Vietnam does have offshore gas, but following the successful development of the giant 3900MW Phu My complex, (which uses gas supplied primarily by BP), further gas-fired expansion has been sidelined as gas use is considered of better value elsewhere.

Following the introduction of the new BOT regulations several coal projects have advanced. After a three year delay, US power company AES and partners reached a 25 year power purchase agreement with EVN for power from its Mong Duong 2, 1240MW, US$1.6bn plant in December. The consortium (AES 90% and Vinacomin 10%) will build the plant next to a Vinacomin anthracite mine. It has gone on to sign a US$1.3bn engineering, procurement and construction (EPC) contract with South Korea’s Doosan Heavy Industries & Construction. The plant will comprise two 620MW downshot-fired combustion technology units, which are due to enter operation by 2015.

The new plant will be built next to the 1000MW Mong Duong 1 project, which is being developed directly by EVN and will comprise four 250MW circulating fluidized bed units that are scheduled to enter operation from 2013.

Also in December, the Export-Import Bank of China signed an agreement to provide EVN with US$300m for the Vinh Tan 2 project. The 1244MW plant will cost about US$1.2bn and began construction in August 2010. The two 622MW steam turbines and a coal wharf will be built under a US$1.38bn EPC contract awarded in late 2009 to China’s Shanghai Electric Group Company. The units are scheduled to enter operation in December 2013 and June 2014, respectively.

Vinh Tan 2 is one of three plants comprising the 4400MW Vinh Tan complex. The 1200MW No.1 project is being developed by a joint venture between China’s Southern Power Grid Company and EVN, while the 1980MW No.3 project is being developed by OneEnergy – a joint venture between Hong Kong’s CLP and Japan’s Mitsubishi – in consortium with EVN and Pacific Corporation. EVN will build a 500kV transmission system from Vinh Tan to Song May to evacuate the power from the entire complex.

Another agreement was signed mid-December to cover the joint construction of two plants, each with two 600MW sets, by a consortium comprising Doosan, the state construction company Lilama, and the National Research Institute of Mechanical Engineering (Narime). Two of the 600MW units will be located at the Quynh Lap-I project and the other two at the Long Phu-2 plant.

And in late December state oil company PetroVietnam signed an EPC contract valued at US$1.2bn with a subsidiary, the PetroVietnam Technical Services Corporation, for the Long Phu-1 coal-fired IPP project. The 1200MW plant, one of three in the Long Phu Power Center, is expected to begin construction in early 2011, with completion in 2015. The plant will use coal imported from Indonesia and Australia.

The focus on coal means Vietnam will become a net importer by 2015. However there is likely to be preference for domestic coal as costs are partly subsidized by the government, according to Vinacomin’s deputy general director, Tran Chien Thang. IPP An Khanh Thermal Power has lined up a deal with Indonesia’s Daya Energi to jointly invest in two Indonesian coal mines, to supply its 300MW plant (An Khanh 2), and other companies are expected to join them as Vinacomin’s import monopoly is dismantled.

Vietnam has little in the way of renewable energy capacity other than its hydropower sector. But potential for both wind and solar is substantial, especially in serving remote areas. There are plans for several wind farms including the 50MW Phuong Mai project.

Embarrassment of riches

2011-02-03T05:49:00.000-08:00

If world is getting wealthier, why do we feel poorer?

Feb. 1, 2011

By Andy Xie

BEIJING (Caixin Online) — Despite the dot-com bust, 9-11, the wars in the Middle East, the U.S. property bubble, the euro-zone sovereign credit crisis, the continuing stagnation of the Japanese economy — the first decade of the 21st century was the most prosperous, according to conventional measurements, in our lifetime.

But the prosperity on paper isn’t reflected in the moods of peoples around the world. In fact, most people around the world say that they are dissatisfied with their economic plight.

The poor quality of economic growth may explain the gap between economic indicators and social moods. The poor growth quality is reflected in (1) inflation of economic necessities, (2) rising debt levels for the support of living standards in the developed world, (3) rising property prices that puts housing out of reach for the middle class in the developing world, and (4) skyrocketing economic inequality that makes the economy dependent on the demand of a small, wealthy minority.

The right path forward is slower but results in more equitable growth. The most important policy change should be to move away from using liquidity to boost economic growth. It is the most important cause of inflation and rising inequality.

While food is getting more expensive, information is getting cheaper.

The combination is highly combustible. This year may see more political instability around the world. Inflation could become another global crisis in late 2012. It would start with either a collapse of the U.S. Treasury market or an inflation-indexed hard landing in the emerging economies.

Unhappy prosperity

In the past decade, the world saw unprecedented prosperity. The global nominal gross domestic product nearly doubled to $62 trillion in the first decade of the 21st century. The dollar decreased by one-fourth in the decade, and the U.S.’s inflation was similar in magnitude, i.e., the global GDP rose by 50% if discounting for the dollar’s depreciation and the U.S.’s inflation.

But, when you travel around the world, the impression one gets from talking to people is of anything but the most prosperous decade.

Americans complain bitterly about life getting harder, less affordable, and more insecure. Europeans complain less only because they have low expectations. The Japanese have given up. They assume things are always bad.

For the Chinese, nominal GDP has quadrupled in the past decade. This achievement ought to produce a sense of satisfaction, but instead, many bitterly lament that things are becoming too expensive, property is no longer affordable, and food and water are less safe.

What’s going on? Is the prosperity a mirage? Is the GDP measurement wrong?

Skewed prosperity

Global grain output has increased by one-tenth in the decade, about the same pace as in the previous decades, and energy by one-third — all much faster than before. Forty percent of the energy output growth came from China increasing coal production. Excluding China’s coal production, the world energy production was sluggish, like in previous decades.

Grain and energy are the most basic inputs in the global economy. As energy and grain affect low-income people most, and the overwhelming majority of the global population falls into this category, their sluggish growth suggests that life hasn’t been improving as quickly as the economic prosperity on paper suggests.

Moreover, as global GDP doubled in dollar terms, far outstripping the output growth of grain or energy, their prices have surged. The FAO global food-price index rose by 138% in the decade, and the Brent crude price rose to about $100 per barrel now from an average of $20 in the 1990s. Even if the average income rose by 90% in dollar terms as the economic data suggest, the outsized price increase in food and energy could have offset that for a big chunk of the global population. A sizable portion of the global population may be worse off today than 10 years ago.

While the inflation of necessities keeps most people down, statistics point to rapidly rising income and wealth for a minority. The top 1% of the U.S. population is getting one-fourth of the national income and nearly half of the national wealth, twice as much as two decades ago. In China, the ratio of property prices to income more than doubled in the decade, indicating that inequality more than doubled too. While the trend may be sharpest in China and the U.S., rising inequality is a global phenomenon.

The surge in income inequality has skewered economic growth toward expenditures by the affluent. Such items have high accounting value and low penetration. Hence, the boom on paper and popular discontent can coexist.

Limited prosperity

If economic data suggest prosperity, it must show up in more of something. One example would be rapid growth in some product or service. I see three booming areas. Two are China-related, and one is U.S.-related.

First, there are more light-manufacturing goods around the world. The rise of China’s manufacturing sector is the driver. From water purifiers and rice cookers to microwave ovens, light-manufacturing goods have become much more ubiquitous around the world. The reason is the lower price level due to China’s rise. Poor people have greater access to such goods.

It is reflected in China’s exports rising from $350 billion to $1.6 trillion in the decade.

These light-manufacturing goods retail for three to four times the factory gate price on the shelves in developed economies and two times the price in developing economies. If you multiply the ratios to China’s export growth, one could say that China’s export boom may account for 15% of the global prosperity.

Second, China’s infrastructure boom is obviously much faster than before and big enough to have a global impact. China’s physical infrastructure — highway, railway, electricity production and distribution — is now similar to the U.S.’s in size. Most of it has been built in the past decade.

Infrastructure is a long-term investment. Its impact cannot just be calculated in terms of today’s GDP. Nevertheless, the $4.5 trillion increase in China’s nominal GDP during the decade could be used to quantify its impact. That amount would be another 15% of global prosperity during the decade.

Third, the IT revolution has continued at a rapid pace. The price of information goods have come down by 90% during the decade. The low price has made IT products affordable to low-income people.

Mobile phones, for example, have become affordable to most people in the world. Even though the nominal value of IT production and information services may be 5% of GDP or so, its massive price decline could explain much of the remaining prosperity.

Exaggerated prosperity

An economic boom tends to center around one or two areas. We know more of the same thing has less value. But, GDP accounting cannot include this factor. When the price of water purifiers drop, more low-income households buy it.

One could argue that its benefit doesn’t diminish with quantity. When everyone has a mobile phone and buys more or exchanges for a better one, the growth of the mobile-phone market clearly carries less benefit than before.

The measurement problem may partly explain the disconnect between economic data and people’s feelings. The global economy has been expanding rapidly in the above mentioned three areas. The marginal benefits have been declining. The necessities like food and energy, on the other hand, have not kept up. Hence, economists can report significant GDP growth. Meanwhile people have become less happy.

Effects of loose monetary policy

Loose monetary policy is increasing inequality around the world.

Globalization and education are usually considered the most important factors in inequality. The former increases the market reach for skills. Hence, people with special skills benefit disproportionately from globalization. But, in reality, engineers, scientists, and computer programers are not benefiting disproportionately from globalization. Their income premium has not increased that much.

Education premiums seem to be significant in developed economies.

There is a sharp difference in the unemployment rate between the college-educated and the rest. In theory, it should be more so in emerging economies, where the average education level is low. The reality doesn’t fit the theory well. Other factors like supply and demand could overwhelm the education factor. The declining wage premium for college graduates in China reflects their rising supply. With blue-collar wages rising faster now, the premium has all but vanished.

Asset markets are more important in driving inequality than other factors. Ones that see wealth or incomes rising rapidly usually participate in or are associated with asset markets. Asset-value-to-GDP ratios have experienced boom-bust cycles. The total value of property and stock has fluctuated between 2 to 5. Ones who get in and out at the right time become rich, the others, poor.

The allocation for income and wealth has mostly become a casino, unrelated to productivity. The reason is that loose monetary policy exaggerates economic cycles and causes the booms and busts.

Central bankers believe in stimulating when an economy weakens. It creates asset bubbles by underpricing money. Monetary activism is the biggest cause of the world’s problems. It has created the “asset-based economy” around the world, marginalizing real economic activities.

The wealth and income concentration through asset markets diminishes the levels of satisfaction in a society. Envy isn’t the main reason. Most people just aren’t becoming better off as time goes on.

Stagflation haunts the world

The global economy is sliding into stagflation. Economic growth rates are slowing down, while inflation is picking up. The International Monetary Fund expects advanced economies to slow to a 2% GDP growth rate in 2011 from 3% in 2010, and emerging economies to 6.5% from 7.1%. Inflation is already above the projected growth rate in both, and it is still picking up.

Further, the inflation of necessities is much higher. When the prices of food and energy rise rapidly, no amount of decline in the price of mobile phones or PCs can offset its negative impact on the well-being of most people, even though it is technically possible in GDP accounting.

The irony is that monetary policy-makers often ignore food and energy in assessing inflation, because they think both are too volatile.

Yes, they are volatile. But amidst the big swings, they have been rising rapidly in the past decade. It is ridiculous to focus on their short-term fluctuations and ignore their long-term trend. It is a matter of time before food and energy inflation spreads to everything else. The spread is now occurring. Even Japan, the land of deflation, is expecting some inflation in 2011.

Today’s inflation follows yesterday’s asset inflation. Loose monetary policy in the name of economic stimulus has been practiced repeatedly in the past decade. Monetary growth went into asset markets first, causing asset inflation without consumer-price-index inflation at first.

Indeed, the so-called effectiveness of monetary stimulus came from creating asset bubbles. The accumulation of monetary stock in asset markets couldn’t last forever. It eventually went into CPI after the burst of the asset bubbles. The central banks added much more money to cope with the effects of the asset-bubble bursting, increasing future inflation.

Inflation is inevitable. The stock of money that fueled the past bubbles and the additional monetary increase for coping with their bursting will all become inflation.

The Year of Living Dangerously

Inflation is squeezing low- and middle-income families that didn’t benefit from or lost out in the past asset bubbles. As living standards fall for a large number of households, social discontent is intensifying. The after-effects of the IT revolution, on the other hand, is making information cheaper. The combination is an explosive mix.

This year began with a big bang in a small country. The people of Tunisia rose and toppled their government. While each eruption like this has its unique context, economic hardship for most people often provides an environment conducive to such events. Inflation is undoubtedly the best indicator for economic hardship. As it is still rising, more eruptions like Tunisia’s are quite likely.

When fighting a fire, the first rule is not to throw fuel into the fire. In today’s inflation fighting, this rule isn’t followed. As I argued above, inflation is inevitable, because the existing money stock is inflationary. To contain inflation, one must increase money supply at a pace in such a way that does not contribute to future inflation. Monetary growth should be less than nominal GDP growth. Its counterpart is for interest rates to rise above the average inflation rate for the foreseeable future, i.e., not tolerating negative real interest rates.

Unfortunately, few are adhering to this principle.

The euro zone’s inflation rate is already above the European Central Bank’s upper limit of 2%. It has threatened to increase interest rates. But, everyone knows it won’t, as the debt crisis continues to affect its Southern economies.

The UK’s inflation rate is at 4%. With a huge budget deficit and an economy that just contracted last quarter, the Bank of England is likely to tolerate inflation. The Fed continues to ignore inflation risks, saying that high unemployment will keep wages under check and inflation down. With a dysfunctional financial system and high unemployment rate, the U.S. will experience inflation behind the others. But, with imports, agriculture and energy accounting for over one-fifth of its GDP, the U.S. can’t escape from the global inflation trend.

Developed economies are reluctant to deal with inflation because they have too much debt. Their indebtedness rose by 50% in the decade before the financial crisis, and they continue to run large fiscal deficits.

Emerging economies are usually passive in their monetary policy. The reason is their dependency on trade and foreign investment for economic growth. They weren’t able to control inflation in previous rounds of loose monetary policy in developed economies. What they have done so far doesn’t suggest otherwise. The key indication is the reluctance in raising interest rates. The interest rate doesn’t rise fast enough to eliminate negative real interest rates.

Prolonged negative real interest rates always lead to financial crisis.

As I have written many times before, the next crisis will start with either a collapse of the U.S. Treasury market or inflation-induced hard landing in emerging economies. The timing is likely to be in late 2012. See this commentary at Caixin Online.

Andy Xie is an economist and board Member of Rosetta Stone Advisors.

Goldman Sachs warns against investing in India, China

2011-02-03T01:49:00.000-08:00

London, January 18, 2011

Goldman Sachs, the US investment banking giant, has issued a short-term alert over investing in India and China due to the impact of rising inflation, advising clients to rotate into Wall Street and other bourses as a safer bet over coming months, a media report said on Tuesday.

"We're not as tactically positive on the BRIC as we have been," said Tim Moe, the bank's chief Asia-Pacific strategist, referring to the quartet of Brazil, Russia, India, and China, the Daily Telegraph reported.

"To be frank, we may have held on too long to our overweight position in China last year. We have decided that discretion is the better part of valour and have tactically reduced our weight. Asia is not in the sweet part of the cycle. The longer-term picture of Asia outperforming the US is taking a breather," he said, speaking at a Goldman conference in London.

The cooling ardour for China is significant shift for the bank that coined the term BRIC and has been the cheerleader of the emerging market story over the past decade.

According to the report, India is an even bigger worry, with yawning twin deficits, and overheating visible on all fronts. The nation's central bank warned this week of "surging inflation".

"India's current account deficit is running at a record pace of 4.1% of GDP and it is 100% funded by short-term portfolio flows, which cannot be relied on indefinitely," said Moe, describing Mumbai's bourse as "crowded".

Goldman insists that the longer-term super-boom remains healthy in both the BRIC nations and a broader group of countries, or "N-11", led by South Korea, Indonesia, the Philippines, Turkey and Egypt.

Goldman expects China to rebound strongly in the second half of the year, distancing itself from the ultra-bearish views of those such as hedge fund star Jim Chanos betting that Beijing will prove unable to engineer a soft landing from its property bubble.

The surprise for 2011 will be a torrid recovery in the US, with growth of 3.4% to 3.8%, as the country confounds critics and averts a post-bubble "Lost Decade".

Even Japan will outshine China, pulling out of its deflation trap, with earnings growth of 23 % this year and 22 % in 2012.

Kathy Matsui, Goldman's Tokyo strategist, said Japanese equities may be the best way to play the Pacific growth story since the average price-to-book ratio is 1.0, compared to 1.9 for China and the rest of emerging Asia.

10 greatest trades of all time

2011-02-03T00:39:00.000-08:00

January 6, 2011

The period of "the Great Moderation," to use Federal Reserve Chairman Bernanke's words, ended in 2007 and ushered in a new era of heightened volatility.

This seismic change mostly destroyed careers on Wall Street, but it also made the careers of people like hedge fund giant John Paulson, who made billions betting against the subprime mortgage crisis.

As a result, there is a renewed interest in the style of trading that's best described as making huge, concentrated bets by analyzing fundamental economic/business conditions. Most (but not all) of these trades can be labeled as 'global macro.'

Paulson's successful trade also prompted talks about it being the greatest of all time.

IBTimes agrees with this assessment and has compiled a list below of the greatest trades of all time, filling in spots two through ten.

The list also includes explanations of the rankings, which were determined by the importance of the underlying events, how much money the trades likely made, and the difficulty and exclusivity of the analyses.

1. John Paulson's bet against subprime mortgages

John Paulson is the famous hedge manager who correctly predicted the subprime mortgage crisis and profited enormously from it.

His trade made his hedge fund $15 billion in 2007 alone. It propelled him from relative obscurity to stardom and his hedge fund to become the third largest in the world.

Paulson does indeed deserve the title of having made the greatest trade ever.

First, he bet big on the largest economic event of the last 70 years and earned billions doing it.

Second, only a handful (less than 10, probably) of players on Wall Street profited enormously from this momentous event. Indeed, compared to other trades on the list, Paulson's prediction is one of the most exclusive.

Paulson isn't even a global macro trader (his background is in merger arbitrage) so it is highly puzzling but impressive that he came up with such an impeccable and spot-on analysis.

He should also be credited for being bold enough to believe in his analysis and ignore his oblivious Wall Street colleagues.

2. Jesse Livermore's call on the Crash of 1929

Jesse Livermore is a legendary speculator from early in the 20th century.

He is famous for correctly predicting both the 1907 and 1929 stock market crashes. The 1929 stock market crash and the subsequent Great Depression was the most significant U.S. economic event in the 20th century.

For his 1907 call, Livermore made $3 million, which is equivalent to almost $70 million today. After his 1929 trade, he was worth $100 million, which is equivalent to over $1.2 billion today.

Like Paulson, Livermore scores points for the high impact of the events he predicted and the amount of money he made.

Furthermore, he made his fortune without the benefit of having a hedge fund (i.e. massive amounts of money from investors) and using fancy derivative instruments.

One last point in Livermore's favor is that he became successful with less educational resources and mentors than modern speculators.

In fact, Livermore is considered a pioneer in the art of speculation and top traders still swear by the Reminiscences of a Stock Operator, a book based on his trading philosophy and career.

3. John Templeton's foray into Japan

Sir John Templeton, born in 1912, is a pioneer of the mutual fund industry and a legendary investor.

In the 1960s, when Japan was beginning its three-decade long economic miracle, Templeton was one of the country's first outside investors. At one point, he boldly put more than 60 percent of his fund in Japanese assets.

Before his brilliant call on Japan, Templeton also correctly assessed the economic impact of World War II, which was the second most important economic event of the 20th century.

In 1939, he put $100 each in 104 U.S. stocks that were trading below $1. In just 4 years, this portfolio quadrupled.

In addition to the fact that he predicted important events, Templeton gets points for being a true pioneer.

Back in the 1960s, people weren't really familiar with the concept of investing in Asia and Japan's export-driven model wasn't yet proven. It took someone of Templeton's ingenuity, courage, and foresight to lead the way.

4. George Soros' breaking of BOE

George Soros put the hedge fund industry on the map in 1992 after he broke the Bank of England (BOE) by shorting 10 billion worth of pound sterling and forcing the U.K. to withdraw from the European Exchange Rate Mechanism (ERM).

Soros made $1 billion in the process, which was an unimaginable sum back then.

Why isn't Soros, probably the most (in)famous trader in the world, and shorting the sterling pound, his most famous trade, ranked higher?

Not to belittle Soros' accomplishments, but the analysis behind it wasn't as difficult as some of the other trades on this list.

Indeed, there were copycats that made the same trade as Soros. Also, far more people recognized the unsustainability of the ERM than those that saw the dangers of the subprime mortgage market.

Moreover, it was Soros' partner Stanley Druckenmiller who came up with the trade idea in the first place. Soros' contribution was agreeing with it and taking a large position.

Still, Soros deserves credit for having the boldness to make the trade. He also gets 'coolness' points for being the catalyst that ushered in a new currency regime for a major country. This level of impact from a single trade is matchless to this day.

5. Paul Tudor Jones' shorting of Black Monday

Paul Tudor Jones correctly predicted and profited handsomely from the Black Monday of 1987, the largest single-day U.S. stock market decline (by percentage) ever.

Jones reportedly tripled his money, making as much as $100 million on that trade as the Dow Jones Industrial Average plunged 22 percent.

In the weeks leading up to Black Monday, many traders were on edge about the market. Some also recognized the danger of portfolio insurance, which was partly responsible for the magnitude of the fall.

Consequently, many had short positions going into Black Monday or advised their clients to get out of the stock market shortly before it happened, so Jones wasn't unique in predicting the crash.

Nevertheless, Jones deserves to be #5 because Black Monday was such a momentous market event and he was the person who made the most money from it.

6. Andrew Hall's $100 oil prediction

Back in 2003, when oil was trading at $30 barrel and the economy had just recovered from the dot-com crash, Andrew Hall wagered that prices would top $100 per barrel within five years.

When oil prices blew past $100 five years later in 2008, Hall's employer Citigroup made a bundle and Hall took home $100 million as a part of his compensation for this and other successful trades.

According to Time Magazine, Hall structured the contracts so that if oil prices didn't hit $100 within 5 years, they would expire worthless.

Therefore, it took a tremendous amount of conviction and probably some brilliant analysis on Hall's part to make that trade.

Traders know it's hard enough to predict the direction of an asset and find a good entry point. What Hall did was actually pinpoint a timeframe and price level of the move.

Hall is known for doing these brilliant (but risky) types of trades. In 2009, for example, he thought spot oil was cheap. However, oil futures were expensive, so he couldn’t buy them. Instead, he actually bought 1 million barrels of real oil and physically stored it.

So while Hall's calls weren't about monumental events in history, he makes up for it by his brilliance and creativity.

7. David Tepper's 2009 bet on financials

In early 2009, David Tepper bought severely depressed shares of big banks like Bank of America (NYSE: BAC) and Citigroup (NYSE: C). By the end of 2009, Bank of America quadrupled in value and Citigroup tripled in value from their bottoms earlier in the year.

That was good enough to earn Tepper's hedge fund $7 billion. His personal cut was $4 billion.

Tepper's background is in investing in distressed assets and that's exactly what he did in his biggest score to date.

In early 2009, everyone knew Bank of America and Citigroup shares were cheap, but they were too afraid to buy because, among other concerns, they were afraid that these banks would be nationalized.

Tepper bet they wouldn't be. While this trade seems like a wild gamble, Tepper's excellent track record in distressed investing proves otherwise.

A more likely explanation is that Tepper kept his cool while everyone else lost theirs with worries about a coming depression, a collapse of the global financial system, and other 'the-world-is-ending' scenarios.

What's not so impressive about Tepper's trade is the caliber and exclusivity of the analysis because everyone knew about the factors at stake, i.e. whether big banks would be nationalized.

But Tepper deserves credit because he did what one else dared to do and made a lot of money doing it.

8. Jim Chanos' prescient shorts

Jim Chanos is the best short-seller in the world.

He correctly predicted, and profited enormously, from the demise of Enron. Other examples of his successful shorts include Baldwin-United, Tyco International (NYSE: TYC), Worldcom and recently homebuilders like KB Home (NYSE: KBH)

Chanos started to look into Enron as early as 2000. When he found red flags, he dug deeper, discovered more discrepancies, alerted the media, added to his short position, and eventually got rich when the Enron scandal was revealed in October 2001 and the company went bankrupt.

The Enron scandal was highly impactful because it was the biggest bankruptcy to date, led to the dissolution of accounting firm Arthur Andersen, and brought about new regulations like the Sarbanes-Oxley Act.

In a way, Chanos' short of Enron is like a miniature version of Paulson's short of the subprime mortgage market; both reached strongly held convictions by painstaking and thorough research and very few people were aware of the landmines these traders discovered.

Chanos is now setting his sights on China because he believes its economy is just a giant bubble.

There are limited ways he can short the Chinese economy, so Chanos won't make as much money as Paulson if he turns out to be right. However, if he is indeed right, he would cement his status as one of the most brilliant analysts of all time (and this list would be revised to reflect that).

9. Jim Rogers' early call on commodities

Jim Rogers spotted the secular bull market for commodities way back in the 1990s. In 1996, he created the Rogers International Commodity Index. Subsequently, he worked on ways to make that index investable.

Since 1998, the index has returned 290 percent through the end of 2010. This compares to the 10 percent return of the S&P 500 Index during the same period.

Rogers expects commodities to continue to rally ferociously for the long term as paper assets become more worthless and demand (for certain commodities) picks up worldwide. If he is indeed correct, the importance of his call will be elevated and this list would be revised to place him higher.

Back in the 1990s, on the heels of a long bear market for commodities, it was difficult to make a bullish case for them. In fact, few people did.

It is therefore highly impressive that Rogers pretty much called the bottom of a market that went on to rally tremendously for the next decade and more.

10. Louis Bacon's geopolitical play

Louis Bacon made a killing in 1990 by anticipating that Saddam Hussein would invade Kuwait. Bacon went long on oil, short on stocks, and helped his new hedge fund return 86 percent that year. In the following year, he also correctly bet that the U.S. would quickly defeat Iraq and the oil market would recover.

Aside from the eye-popping returns, this feat is included on the list because Bacon ventured outside the field of finance and correctly anticipated a geopolitical event.

Granted, his analysis likely centered on the financial difficulties of the Iraqi government, so it wasn't entirely outside his area of expertise.

But Bacon's feat was impressive because he likely anticipated the invasion better than the people who are supposed to be good at this stuff, like the U.S. President, director of the CIA, and top government officials of other countries. These government people also had better information and access than Bacon did.

HIV Preexposure Prohylaxis

2011-01-26T20:50:00.000-08:00

Daily Pill Greatly Lowers AIDS Risk, Study Finds

November 23, 2010

By DONALD G. McNEIL Jr.

The New York Times -- Healthy gay men who took an anti-AIDS pill every day were well protected against contracting H.I.V. in a study suggesting that a new weapon against the epidemic has emerged.

In the study, published Tuesday by the New England Journal of Medicine, researchers found that the men taking Truvada, a common combination of two antiretroviral drugs, were 44 percent less likely to get infected with the virus that causes AIDS than an equal number taking a placebo.

But when only the men whose blood tests showed that they had taken their pill faithfully every day were considered, the pill was more than 90 percent effective, said Dr. Anthony S. Fauci, head of the infectious diseases division of the National Institutes of Health, which paid for the study along with the Bill and Melinda Gates Foundation.

“That’s huge,” Dr. Fauci said. “That says it all for me.”

The large study, nicknamed iPrEx, included nearly 2,500 men and was coordinated by the Gladstone Institutes of the University of California, San Francisco.

The results are the best news in the AIDS field in years, even better than this summer’s revelation that a vaginal microbicide protected 39 percent of all the women testing it and 54 percent of those who used it faithfully.

Also, Truvada, a combination of tenofovir and emtricitabine that prevents the virus from replicating, is available by prescription in many countries right now, while the microbicide gel is made in only small amounts for clinical trials.

The protection, known as pre-exposure prophylaxis, is also the first new form available to men, especially men who cannot use condoms because they sell sex, are in danger of prison rape, are under pressure from partners or lose their inhibitions when drunk or high.

It “does not involve getting permission from the other partner, and that’s important,” said Phill Wilson, president of the Black AIDS Institute, which focuses on the epidemic among blacks.

Michel Sidibé, the head of the United Nations agency that fights AIDS, called it “a breakthrough that will accelerate the prevention revolution.”

AIDS experts and the researchers issued several caveats about the study’s limitations, emphasizing that it looked only at gay men and Truvada. More studies, now under way, are needed to see whether the results can be duplicated, whether other antiretroviral drugs will work and whether they will protect heterosexual men and women, prostitutes and drug users who share needles.

There is no medical reason to think the pill would not work in other groups, since it attacks the virus in the blood, not in the vaginal wall as a microbicide does. Pre-exposure prophylaxis became possible only in recent years as newer, less-toxic antiretroviral drugs were developed.

Some scientists fear that putting more people on the drugs will speed the evolution of drug-resistant strains, though that did not occur in the study.

Because Truvada is available now, some clinicians already prescribe it for prophylaxis, Dr. Fauci said, but whether doing so becomes official policy will depend on discussions by the Centers for Disease Control and Prevention, the Food and Drug Administration, medical societies and others, which could take months.

Although the C.D.C. would prefer that doctors wait for further studies, more will probably prescribe the drugs now that this study is out, said Dr. Kevin Fenton, chief of the agency’s AIDS division, so the C.D.C. will soon release suggested guidelines.

The agency will suggest that the drug be prescribed only with close medical supervision and used only with other safe-sex practices.

“The results are encouraging, but it’s not time for gay men to throw away their condoms,” Dr. Fenton said.

AIDS advocacy groups were very excited by the results.

“If you comply with it, this works really well,” said Chris Collins, policy director of amfAR, the Foundation for AIDS Research. “This is too big to walk away from.”

Mitchell Warren, executive director of AVAC, an organization that lobbies for AIDS prevention, called the study “a great day for the fight against AIDS” and said gay men and others at risk needed to be consulted on the next steps.

In the study, 2,499 men in six countries — Brazil, Ecuador, Peru, South Africa, Thailand and the United States — were randomly assigned to take either Truvada or a placebo and were followed for up to three years. For ethical reasons, they were also given condoms, treatment for venereal diseases and advice on safe sex. There were 64 infections in the placebo group and 36 in the group that took Truvada, a 44 percent risk reduction.

Two in the Truvada group turned out to have been infected before the study began. When the remaining 34 were tested, only 3 had any drug in their blood — suggesting that the other 31 had not taken their pills.

Different regimens, like taking the pills not daily but only when sex is anticipated, also need testing.

Also, many men in the study failed to take all of their pills, and some clearly lied about it. For example, some who claimed to take them 50 percent or 90 percent of the time had little or no drug in their bloodstreams.

The pills caused no major side effects, though men who began to show signs of liver problems were taken off them quickly. Some men stopped taking the pills because they disliked relatively minor side effects like nausea and headaches. Also, some stopped bothering once they suspected that they might be taking a placebo.

“People have their own reasons,” Mr. Collins said. “People don’t take their Lipitor every day either.”

A major question now is who will pay for the drug.

In the United States, Truvada, made by Gilead Sciences, costs $12,000 to $14,000 a year. In very poor countries, generic versions cost as little as 40 cents a pill.

Globally, only about 5 million of the 33 million people infected with the AIDS virus are on antiretroviral drugs, and in an era of tight foreign-aid budgets, that number is not expected to rise quickly.

Hundreds of millions of Africans, Eastern Europeans and Asians are at risk and could benefit from prophylaxis, but that would cost tens of billions of dollars.

In this country, insurers and Medicare normally pay for the drugs, and the Ryan White Act covers the cost for the poor, but none of these payers yet have policies on supplying the drugs to healthy people.

No participant in the study developed resistance to tenofovir. Three were found to have strains resistant to emtricitabine, but investigators believe that all three were infected before the study began at levels low enough to have been missed by their first H.I.V. tests.

Another concern was that the participants would become so fearless that they would stop using condoms, but the opposite effect was seen — they used condoms more often and had fewer sex partners. But that can also be a result of simply being enrolled in a study and getting a steady diet of advice on safe sex and free condoms, the investigators said.

Other trials of pre-exposure prophylaxis have about 20,000 volunteers enrolled around the world. Their results are expected over the next two years.

As AIDS epidemic ebbs, many challenges remain

By David Brown
Washington Post Staff Writer
Tuesday, November 23, 2010; 11:41 PM

The AIDS epidemic has crested and started to recede almost everywhere in the world, but it has left behind millions of people who urgently need treatment if they are going to avoid adding to the disease's toll of 30 million dead over the past 30 years.

That is the gist of the annual portrait of the global AIDS epidemic, released Tuesday by UNAIDS, an agency of the United Nations and World Bank.

AIDS incidence and mortality have been declining for several years, and the new report, which includes data through the end of 2009, confirms that the trend is clear and undeniable.

"We can say with confidence and conviction that we have broken the trajectory of the HIV/AIDS epidemic," said Paul De Lay, deputy director of UNAIDS, which is based in Geneva. "There are fewer people infected, and there are fewer people dying."

The downward decline is the consequence of many forces, including sexual behavior change among young people, success in preventing mother-to-child transmission of the virus, and the lower infectious risk of people who are successfully taking AIDS drugs. It also reflects the epidemic's natural history, in which the annual number of new infections peaks and then declines as the disease "saturates" high-risk groups in the population.

In 2009 there were 33.3 million people living with HIV infection, compared with 26.2 million in 1999. However, the number of new infections in 2009 was down 16 percent from a decade ago - 2.6 million versus 3.1 million. The number of AIDS-related deaths peaked in 2004 at 2.1 million, and last year was down to 1.8 million.

Among the hopeful trends is the rapid increase in the number of people in the developing world taking the combination antiretroviral therapy that since 1996 has revolutionized AIDS care in rich countries.

In 2009 there were 5.2 million people in the developing world on the drugs, a 30 percent increase over the previous year. (Treatment of about 2.5 million of those people is paid for by the U.S. government). However, 10 million people need treatment but aren't getting it.

The report also described some discouraging developments.

In more than a half-dozen countries, HIV infection rates went up more than 25 percent in the past decade. In the United States and Western Europe, an epidemic in gay and bisexual men continues to grow unabated. There are still two new people becoming infected for every one person who starts treatment, although that is better than two years ago, when there were five new infections for every two people starting treatment.

In 2009, about $15.9 billion was spent on the global AIDS response, with slightly more than half the money provided by low- and middle-income countries. However, much more money, about $26.8 billion, is needed annually to fully fund treatment, care and prevention, the report said.

Equally troubling, according to the report, was that in 2009 the amount of money - $7.6 billion - provided by wealthy countries to treat and prevent AIDS overseas was a tad lower than in the previous year.

"This is coming at the wrong moment, just as we are seeing the investment pay off," said Michel Sidibe, executive director of UNAIDS. "For me, it will be immoral to bring more than 5 million people on treatment and to possibly then say, 'We do not have the means to pay for that treatment.' "

Sub-Saharan Africa is home to about two-thirds of the people in the world living with HIV. The continent's total number of infected, about 22.5 million, continues to grow, in part because of the longer survival of people who have started taking antiretroviral drugs. In 22 of the region's nations, however, the annual number of new infections has dropped by more than 25 percent in the past decade.

A dramatically upward trend has occurred in a few places.

In Eastern and Central Europe, the number of people with HIV has tripled since 2000, with the most infections acquired through drug use.

The number of children infected at birth has fallen nearly 25 percent in five years. The fraction of infected pregnant women who get medicines to prevent passing the virus to their babies is just over 50 percent, up from 35 percent in 2007. But only 15 percent of the women are then put on a permanent course of antiretroviral therapy, which is a big problem, Sidibe said.

"We need to make sure that when we save the baby that we don't abandon the mother. That is a major challenge that I am fighting to make sure we change," he said.

Preventing HIV with drugs: What now?

By Thomas H. Maugh II
November 23, 2010

Los Angeles Times -- Tuesday's announcement that a once-daily pill containing two HIV drugs could block new infections from the AIDS virus by more than 70% if people take the pill religiously has created a major stir in the AIDS-prevention world, offering the first promise that something can be done to block transmission of the virus in men. A study released in July showed that a microbicidal gel used by women could block transmission of the virus by as much as 54% when used faithfully, but the new study is the first to demonstrate a successful prevention approach in men, and it got even better results.

The approach involved pre-exposure prophylaxis, in which subjects are given an anti-HIV drug before they are exposed to the virus -- a technique that has been used for some other diseases as well. The study, conducted by Dr. Robert M. Grant of the Gladstone Institutes of Virology and Immunology at UC San Francisco and Dr. Javier R. Lama of Investigaciones Medicas en Salud in Lima, Peru, enrolled 2,499 gay men and transgender women, who were given daily doses of Truvada or a placebo for an average of 14 months.

Gay men were chosen both because they were at high risk of contracting HIV and thus could provide an effective test of the approach in a relatively short time and because controlling infections in this group was a key part of any anti-HIV strategy. Gay men account for 53% of new HIV infections in the United States and a significant percentage of infections in developing countries, according to Dr. Anthony S. Fauci, director of the National Institute of Allergy and Infectious Diseases, which provided the primary funding for the trial.

On average, those receiving Truvada had a 43.8% reduction in risk of contracting HIV, but those who took it more than 90% of the time had a 72.8% reduction in risk.

"This is the first proof that oral pre-exposure prophylaxis works in people," Grant said, "and the first proof that any biomedical intervention can prevent HIV infection in gay and bisexual men."

Actually taking the drug proved to be crucial. When researchers tested the levels of Truvada in the blood of the 36 patients in the treatment arm of the trial who contracted HIV, they found no drug at all in 91% of them and only barely detectable levels in the rest. "That could explain all the infections," Grant said.

Truvada, a combination of the drugs emtricitabine and tenofovir, is manufactured by Gilead Sciences of Foster City, Calif., which provided the drug and the placebo for the trial. It is considered effective and relatively safe and is already used by more than 1.5 million people around the world. In the United States, it costs from $12,000 to $14,000 per year, but it is available in generic form in many countries for as little as 40 cents per day.

The researchers did not observe development of resistance to the drug in any of the study participants who were HIV-free at the beginning of the trial, but resistance did develop in three who were HIV-positive at the start. Experts says it is crucial that anyone planning to begin using Truvada have an HIV test to make sure they are not already infected.

Should you use it? Some doctors already have been prescribing it to selected patients that they think are at high risk, and others will probably do so now that these results have been published. But most experts think it is still too early for widespread use, particularly in any groups other than gay men. More studies are already underway to determine whether it can protect heterosexual men and women, prostitutes and intravenous drug abusers. Studies also will investigate whether other drugs will work as well.

Grant noted that his team also will study ways to increase adherence to the drug regimen in hopes of further reducing HIV risk.

Buffett speaks on who might succeed him

2011-01-08T04:36:00.000-08:00

By Vanity Fair; January 5, 2011

The future of Berkshire Hathaway is the subject of intense speculation throughout the financial world, for millions of investors and at the company itself. “It is all we talk about [at board meetings],” Warren Buffett tells Vanity Fair’s Bethany McLean, who spent 11 hours in Omaha with the octogenarian Berkshire Hathaway C.E.O. to discuss who might lead the company he founded when, as David Sokol, one of his executives, puts it, “the bus hits.” Buffett, who has no plans to retire, tells McLean that he “tap dances to work.” His partner and vice-chairman for more than 40 years, Charlie Munger (who, at 86, is not a contender) also speaks to McLean for a profile that provides an in-depth look at Warren Buffett’s thinking on succession as well as the possible choices. Buffett also talks to Vanity Fair about the evolution of his investment strategy, his trust in the wisdom of American capitalism, his “pragmatic” investment style, and belief in luck.

With Buffett’s offspring out of the running, there is no heir apparent for a company whose identity is deeply tied to its founder. Buffett himself describes Berkshire Hathaway as his work of art. “I’m getting to paint my own painting,” he tells McLean, “and if I’m using red, no one is saying, ‘Why don’t you use a little more blue?’ It’s enormous fun. I get applause. I like it when people cheer for my painting.” Still, Buffett assures McLean that Berkshire Hathaway will go on without him and that he has made provisions for this. “There is no end point for Berkshire Hathaway,” he says. “The important thing is not this year or next year, but where Berkshire is 20 years after I die. Not taking care of Berkshire would be like not having a will—cubed.” Sokol tells McLean that the company is “60 percent Warren Buffett and 40 percent Berkshire Hathaway,” but adds, “The culture will have to make that 100 percent over time.” Buffett also speaks of the enduring Berkshire Hathaway “culture”: “There will be a lot of things built in to make sure that if something is really eroding the culture, then changes can be made,” he says.

“This much,” McLean writes, “is known: the roles of the chief investment officer . . . and the chief executive officer . . . both of which are now filled by Buffett, will be split between at least two people, and probably more.” There are rumored to be at least four C.E.O. candidates (the “most important” of his two roles, according to Buffett), all from inside Berkshire Hathaway. Sokol, a fellow Nebraskan, “is the top pick of most Buffett-watchers,” McLean writes. His number two, Greg Abel, is another name that is often mentioned. Ajit Jain, a Buffett lieutenant “with whom Buffett talks almost every day,” and Matthew Rose, who runs Burlington Northern, a Berkshire Hathaway-owned company, are the other possibilities.

“Finding a C.I.O. has proven even more challenging. Apart from the issue of skill, there’s the issue of personality,” McLean writes. Buffett says: “Take all the people with a great track record [in investing] over the past five years. I wouldn’t consider 95 percent of them.” Last July The Wall Street Journal reported that Buffett had his eye on Li Lu, a 1989 Tiananmen Square protest leader turned hedge-fund manager. On that matter, McLean reports, “all Buffett will say is that Li preferred to stay where he was.”

Buffett discusses the private-equity way of investing, which he calls “love of money over love of business.” Berkshire Hathaway is known for its hands-off approach to dealing with the companies it acquires, making them the “buyer of first resort.” Buffett admits to McLean that he detests stepping in, possibly to a fault. “There are things where I’ve had to get involved, but I’ve usually done it through other people,” he says. “Every time I am later than I should be. It’s the only thing about my job that I hate. I would give up a big percentage of my net worth if I didn’t have to do this. I hate it. Therefore, I put it off and I procrastinate.”

The lifelong Democrat, who recently announced that he was donating the majority of his wealth to the Gates Foundation, came under fire for a New York Times op-ed piece he wrote in November thanking the Bush administration for the Wall Street bailout. “I felt that they deserved thanks,” he tells McLean. “People should see that the government can do things right.” He adds, “I may not have convinced anyone, but it should mean something when I say George Bush was right!” Bush’s September 2008 declaration “If money isn’t loosened up, this sucker could go down!” Buffett calls “the 10 most immortal words in the history of economics.”

Warren Buffett gave Vanity Fair an advance look at his 2011 letter to shareholders, which goes out in March. In it he quotes a missive from his grandfather, who believed in keeping some cash on hand for emergencies. “For your information, I might mention that there has never been a Buffett who ever left a very large estate,” Earnest Buffett tells his descendants, “but there has never been one that did not leave something. They never spent all they made.” The letter to the shareholders will also address last year’s hire of 39-year-old Todd Combs, who could one day be the C.I.O. of Berkshire Hathaway. “Our goal was a two-year-old Secretariat, not a 10-year-old Seabiscuit,” Buffett plans to write, adding, “Not the smartest metaphor for an 80-year-old C.E.O.”

Rivaling Buffett’s confidence in Berkshire Hathaway is his faith in the United States. “We had four million people here in 1790,” he tells Vanity Fair. “We’re not more intelligent than people in China, which then had 290 million people, or Europe, which had 50 million. We didn’t work harder, we didn’t have a better climate, and we didn’t have better resources. But we definitely had a system that unleashes potential. This system works. Since then, we’ve been through at least 15 recessions, a civil war, a Great Depression…. All of these things happen. But this country has optimized human potential, and it’s not over yet. It’s like what’s written on the tomb of Sir Christopher Wren: If you seek his monument, look around you.”