How are Santa's gifts financed?

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Peace is a gift but also has to be earned, the Pope said in his 2001 Xmas
message. The WSJ reported on Xmas eve that Bush targets enivironment, public
works to defray cost of war on terrorism. On
a Christmas Day visit to sailors in the Arabian Sea, Gen. Tommy Franks
said that anti-terrorism operations are being conducted around the world.

Shooting war has begun on Xmas day in Kashmir between Indian and
Pakistani troops .

On the home front, the NY Times reportsd he holiday shopping season opened the day after Thanksgiving with nervous merchants cutting prices 40 percent.  It ended over the final weekend before Christmas with a frenzy of desperation sales with as much as 70 percent off that failed to save the season for most retailers.  Zero-percent financing deals from Detroit's automakers also siphoned off many of the extra dollars consumers might have taken to the malls.    "It is taking extraordinary measure of near desperation to keep  consumers afloat," said Stephen S. Roach, chief economist for Morgan Stanley. "The question now is how much of what we are seeing now is borrowed from gains that would have come next year."

Moody's Investors Service downgraded Kmart's debt to junk status. The discount retailer has had trouble meeting modest sales targets despite extended hours and ferocious price cuts ? like 70 percent off its gold and diamond jewelry. Moody's also downgraded the outlook for the Limited, parent company of Express, and is reviewing Gap's credit. Gap, which also operates the Banana Republic and Old Navy chains, has suffered a devastating season. Just to clear unwanted sweaters, pants, and underwear, Gap's lineup of retailers has put an unprecedented amount of merchandise on sale. Even seasonal items like thigh-length hand-knit sweaters were marked down to $34.99 from $98. Back to Basics hs run out of appeal.  The Gap's downfall has been the most spectacular of the season, but mall-based specialty clothing stores were hit hard across the board as the cathedrals of consumption did not seem to draw the usual immense crowds on the last weekend before Christmas, which has replaced the weekend after Thanksgiving as the busiest shopping burst of the year.  Since last March, ehich officially marked the beginning of the recession, consumer spending has been identified as the anchor against a recession.  A reverse "wealth effect" is at work through mega bankruptcies.  Billions vanished from the pension accounts of Enron employees.  Word on the Street is that more mega bankruptcies are lining up close behind Enron, in telecommunication and financial sectors.  The first signs of weakness in real estate are now visible.

The Washington post headlines: Once Again, War Is Good for Business.  Once the uncool cousin to high-flying dot-coms, government contractors adopted a new swagger in 2001. The industry continued a trend toward consolidation that strengthened already large companies going after ever-larger federal contracts. Nearly across the board, stock in such companies surged after Sept. 11.  An extreme example was CACI  International Inc. of Arlington, the  stock price of which nearly doubled before a 2-for-1 split in November.   Expectations for the sector are high.   Before the terrorist attacks, the federal government was expected to spend  $46.3 billion on information technology this fiscal year, which ends next September. Now, the  Government Electronics and Information Technology Association predicts that federal spending on  information technology will jump to $49 billion this fiscal year and reach $65 billion in fiscal 2007.

As the government focuses on homeland security, federal agencies are considering how to secure their
computer networks and continue to offer more services to the public on the Internet.  Contractors in the intelligence field in particular should benefit over the next few years, analysts said.

"Even before the terrorist attacks . . . federal government outsourcing was on the rise, and defense spending, after 15 years of decline, was poised for growth," Legg Mason analyst Bill Loomis said. "Now the outlook is even more favorable for federal government contractors."

The government technology was already revitalizing. Even before Sept. 11, companies that usually deal in the private sector market had their eyes on government business. "Until there is a drastic change, we will see more and more companies trying to get into government," said Thomas Meagher, an analyst for BB&T Capital Markets. Others, such as Bethesda-based Lockheed Martin Corp. and SRA International
Corp. continued to grow through acquisition. In October, Lockheed Martin agreed to buy OAO Corp., a Greenbelt-based federal information technology firm. SRA International, a Fairfax government information technology contractor,  purchased Marasco Newton Group, another privately owned information technology firm.

Computer Science Corp. of California won a 10-year $2.5 billion contract to take over technology services for the National Security Agency. One thousand NSA employees will become Computer Science employees in the biggest outsourcing arrangement ever for a federal agency. New York-based International Business Machines Corp. New York-based IBM Corp. won a $1.3 billion contract to overhaul the U.S. Customs Service's computer system.

If the sector's positive outlook was not already evident, ManTech International Corp., a Fairfax technology services company, said in November that it would raise as much as $92 million in an initial stock offering, one of only a few IPOs this year in any industry. More IPOs by government-technology firms could be on the horizon.

For example, the administration is likely to seek as much as a $12 billion increase in homeland security for 2003, over the $18 billion included for continuing programs in the just-enacted 2002 budget. (The administration also allocated about $4 billion to $5 billion for 2002 for one-time expenditures on such things as vaccines.) Defense spending also will rise. Such increases are encouraging talk of belt-tightening in other areas.

Initially, President Bush sought to limit the growth of discretionary spending for 2002 to 4%. Instead, thanks to congressional intransigence, as well as added costs for defense modernization, war and homeland security, the discretionary budget increased by at least 11% in 2002 from 2001 -- the most since the 12.8% increase of 1980. That includes $686 billion in regular spending and $20 billion of the $40 billion in emergency funds that Congress approved in September. Congress attributed only half of the $40 billion to this year's budget total, putting the rest in fiscal 2001's tally -- but if all of it is included, spending rose by 15%.

Even a relatively conservative budget for 2003 could reach $740 billion for discretionary programs, from the $706 billion total for 2002, according to preliminary calculations by Senate Budget Committee Republicans.

The administration hopes to keep total spending below $740 billion for 2003, including emergency funds. But OMB director Mitchell Daniels Jr. already has let it be known that the 2003 budget will increase by at least the rate of inflation. And an administration official said last week that the budget apart from defense and homeland security won't decrease overall, and could actually increase somewhat.

Meanwhile the looming yen crisis is being described as a financial 9:11 for Asia.
Japan may be brewing a financial crisis that will see runs on deposits, government bond yields blowing out and a forced state-funded recapitalisation of the banking system.

The large amount of savings held in call deposits by deeply conservative Japanese households could prove to be the undoing of a banking system already saddled with a heavy burden of non-performing loans.  Banks had at least 44 trillion yen in non-performing loans as of March, according to official figures. The
real figure could be as high as 100 trillion yen against capital of only 13 trillion yen.  Analysts suggest that the weakness of the banking system is itself now a factor in the deterioration in the underlying economy and the deterioration of the economy will further visibly weaken the banking system.  At some stage, unknowable in advance, the shortage of capital in the banking system is likely to undermine confidence. It seems doubtful that the regulatory authorities can act with sufficient speed and size to offset this feedback. Since the property and stock market bubbles burst in 1990, households have put most of their money in bank deposits rather than spend or invest it.  That has meant 23.8 per cent of the banking system is funded by deposits and the ratio of M1 money supply to currency in circulation is as high as 4.4 in Japan, against 2.4 in South Korea and 2.1 in the United States.  A spate of bankruptcies among bank [loan] clients is the messenger which delivers the bad news to the Japanese saver that his banks are
no longer safe.  The result is likely to be a liquidity rush and the forced recapitalisation of the banks as a precondition for halting the rush. If depositors rushed to remove their money, banks would be forced to
sell down their huge positions in Japanese government bonds to raise the cash, sending bond prices down and raising yields.  The banks had 40 per cent of their 168 trillion yen securities holdings in government bonds and owned 16.3 per cent of the market in the instruments.  Rising government bond yields would add significantly to Tokyo's massive debt burden. A one percentage point rise in yields would cost the  Government an additional 2.4 per cent of tax revenues in higher debt-servicing costs. The Government already uses 34 per cent of tax revenues in debt servicing.  A vicious cycle could ensue of rising government bond yields hitting Tokyo's creditworthiness, leading to a further rise in yields.
Given this scenario, nationalising and recapitalising the banks in order to forestall a serious bank run seems like a bargain, according to Western bankers.  Banks would have existing shareholder capital written down, then be given new government bonds in return for Tokyo taking all the 100 trillion yen in bad loans off their books.  But any financial crisis will inevitably cause the currency to fall in the short term, no matter what the ultimate monetary implications of the crisis turn out to be.

A catalyst for the crisis might be further bankruptcies such as seen recently with retailer Mycal, which was not classified as a bad debtor by many banks.  Bank regulators' inspections into how loans have been categorised,  which are expected to reveal under-reporting of problems, might also spook depositors.

As for Argentina, Santa simply skipped it this year, after a decade of bringing stockingfuls of dollar debt insured by a currency board that milked the local economy. At least the Japanese understand that a strong currency does not necessarily reflect strength in the economy.

Henry C.K. Liu